Creating insurance markets for natural disaster risk in lower income countries: the potential role for securitization

Abstract

This article considers the potential for securitizing index‐based insurance products that transfer weather and natural disaster risks from lower income countries. It begins with a brief overview explaining why markets for natural disaster risks are important, yet often missing, in lower income countries and a review of some recent activities using index‐based weather insurance. Next, we describe how natural disaster risks are handled in higher income countries. These examples, along with the example of an innovative index‐based livestock insurance pilot project in Mongolia, illustrate how layers, or tranches, of natural disaster risk can be financed during the product development phase by creating structures similar to the Special Purpose Vehicles used in catastrophe bond, mortgage bond, and the emerging microfinance bond markets. We refer to these investment alternatives as micro‐CAT bonds since the principle amounts would be small relative to the existing CAT bond market.