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Catastrophe Bonds: Another Tool to Raise Preparedness for Fiscal Pressures Stemming From Natural Disasters

Natural disasters can generate significant losses in terms of both human lives and destruction to physical assets, potentially resulting in considerable and sudden fiscal costs for the public sector. In this commentary, we explore the potential advantages and challenges of using catastrophe bonds (CAT bonds) to mitigate post-natural disaster stress on public finances that can be overwhelming in some countries. While the potential occurrence of such natural events will be negative for a sovereign's credit profile, especially for smaller countries and islands highly exposed to these types of catastrophe, the use of funding mechanisms such as CAT bonds, issued prior to, rather than public debt issued in the midst of a crisis, provides a useful tool for raising fiscal preparedness.

• The fiscal cost of natural disasters—such as earthquakes, hurricanes, wildfires, and floods—could be significant, especially for small countries with historically large exposure to these events.
• The use of CAT bonds to insure against natural disasters as a pre-financing tool can alleviate the ensuing fiscal pressures after such events.
• The market for public-sector CAT bonds remains relatively shallow and faces some challenges that could prevent it from scaling-up at the moment.

“In our view, CAT bonds can be a useful tool for financial planning for low- and middle-income countries with high exposure to natural disasters, but are unlikely per se to materially improve a country's credit profile given its limited current usage,” said Javier Rouillet, Vice President, Global Sovereign Ratings at DBRS Morningstar. “There is significant scope for development in the public-sector CAT bonds market in the coming years, however, its size is likely to remain relatively small in the near term, in our view,” added Javier Rouillet.