Catastrophes and Correlations

In 2017 the World Bank issued some pandemic bonds. Investors who bought these bonds got a high interest rate, but they could lose all their money if there was a pandemic: The bonds would “trigger” if a pandemic occurred, and then instead of paying back the bondholders, the money would go to the World Bank to fund relief efforts. The bonds “were originally conceived as a sort of public-private partnership to get insurance investors to assume some of the risk of the Ebola epidemic.”

Obviously the current coronavirus outbreak is of interest to pandemic-bond investors, and John Dizard has a fascinating column in the Financial Times about the virus and the bonds. There are a lot of classic financial-engineering lessons in these bonds. For instance, I just said that the bonds trigger if a pandemic occurs, but what exactly does that mean? Well, there’s a long document with specific provisions describing what does and doesn’t qualify as a pandemic, and—as is so often the case in financial-contract triggers—there is room for debate and gamesmanship. So it’s not a pandemic unless there are deaths in multiple countries—a devastating epidemic in one country would not trigger the bonds—and so you get this gruesome speculation: