Zane Morais, Futa Takahashi – London School of Economics and Political Science (LSE)
Pandemic bonds have been placed under a microscope ever since the idea was proposed in 2015 after a deadly wave of Ebola outbreak. It has been questioned numerous times over the years with regards to its complexity and its lack of necessity. Saving up money for the purposes of a future pandemic seemed like the perfect idea in theory – to find out why this innovative idea did not hit its mark, we need to investigate the reasons behind its conception in the first place.
What are pandemic bonds?
Former World Bank president Jim Yong Kim set out to create a brand new product that had the capability to fund future pandemic relief by transferring pandemic risk to the public financial market. Investors would receive coupons and the occurrence of a pandemic would affect the return on their investment. Should there be an outbreak, the money invested would be used to cover the response to the pandemic. However, the incentive to the investors was that their investment would mature, with different interest rates being used based on the risk of the investment. Investing in a riskier bond would incur a greater interest rate, and the slim chances of an outbreak actually taking place only increased the appeal for investments. Although the concept of investing in these bonds sounds difficult to grasp, it is a simple case of putting aside money for later use, as so many of us do today with our savings.
Problems with Pandemic Bonds
Although the pandemic bond might seem like a great system to finance devastated countries and transfer risks, it also possesses many issues. One caveat of the pandemic bond is the loose definition of a “pandemic”. Pandemic bonds were created to finance developing countries in case of emergencies related to pandemics. In order to efficiently execute this process, speediness is essential. However, this is not exactly how pandemic bonds worked during the COVID-19 outbreak. Pandemic Emergency Financing Facility (PEF) states pandemic as follows;
- Outbreak size: more than 250 cases, with a minimum of 250 deaths in developing countries and over 12 weeks since the start of the outbreak.
- Confirmation ratio: at least 20% of total cases need to be confirmed.
- Cross-border spread: at least 2 countries must have cases, with a minimum of 20 fatalities.
- Positive growth rate: the total number of cases in developing countries must be growing at a faster rate as time passes (as confirmed by a third-party agent, AIR Worldwide).
These criteria were met only on the 17th of April 2020, more than a month after the WHO’s announcement of the COVID-19 pandemic and four months after the first COVID-19 case. Although PEF was able to finance developing countries with more than $195 million over the next 6 months, speed is the key to prevent pandemics and this still remains an issue for pandemic bonds.
Another problem with the pandemic bond is its structure. As Jintao Zhu from the London School of Economics and Political Science points out, the structure of the pandemic bond is a trilemma (two factors can be met but not all three factors can be met simultaneously). The three main factors in question are; effectiveness, efficiency and investability.
Effectiveness represents the speediness of the pandemic bond. As mentioned earlier, this remains one of the major problems with the pandemic bonds. Efficiency represents a financing source. Currently, pandemic bonds are mainly sourced by private sectors such as investors and reinsurance companies. There are public funds like Germany, Japan and Australia’s donation but since a pandemic is an international challenge, thorough funding is required. Investability represents whether a pandemic bond appeals to investors. To attract investors, either effectiveness or efficiency will be neglected. As the latter two factors are the main objectives for pandemic bonds, public funding or some sort of structural reformation is necessary to prepare for unpredictable pandemics.
Disruptive Opportunity Perspective
Traditionally, insurance companies have suffered from sudden and unpredictable disasters like pandemics. These catastrophic events will cause a surge in insurance company’s payouts, sometimes ending up in bankruptcy. To prevent this, insurance companies will usually sell their underwritings (insurance certificates) to reinsurance companies (reinsurance is insurance for insurance companies). Reinsurance companies would then distribute the risk associated with the underwritings to other insurance or reinsurance companies and/or to private investors and so on. Pandemic bond has added a new method for risk transfers within the reinsurance market. The more options there are the less concentration of risks. Although pandemic bonds still have numerous revisions and structural changes to make, this new idea was definitely a disruption to the reinsurance market. This article hopefully provided some insight into pandemic bonds and how they operate, and also a brief introduction to reinsurance, which will be explored in a future article.