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Development, Debt, and Disaster Risk in ‘Nature’s Casino’

by Beki McElvain, PhD, University of California, Berkeley

June 18, 2024

Key Takeaways

  • Catastrophe (cat) bonds are debt-driven insurance instruments increasingly used by development finance institutions to cover disaster risk considered uninsurable by traditional means

  • Cat bonds use strict 'parametric' criteria to determine what qualifies for coverage, which often leaves some areas without support after a disaster that doesn't meet those specific conditions

  • Cat bonds prioritize protecting investors and the financial market over people and infrastructure, allowing wealthier countries to profit by taking financial risks on disasters in poorer regions

As climate-related disasters become more frequent and severe, countries in the Global South continue to bear the biggest costs of the crisis. In the most vulnerable regions—Latin America, Africa, and South and Southeast Asia—access to insurance and climate finance for adaptation and mitigation is limited or relies on high-interest loans. In these regions, complex challenges are aggravated by long-standing relationships with development finance and debt-dependence. These relationships involve practices that increase environmental and economic risk through irregular urbanization and fuel political uncertainty and corruption, making it hard for countries to establish their own sovereign climate agendas.

Institutions like the World Bank and the International Monetary Fund (IMF) have been intervening in Global Southern countries since the Bretton Woods Agreement of 1944, requiring policy reforms in exchange for funding to alleviate poverty and, in theory, drive growth. More recently, the World Bank and IMF have begun setting the terms for worldwide disaster governance and underwriting debt-driven tools for mitigation and adaptation to disaster risk. Aligned with the UN Sustainable Development Goals for mobilizing private capital to address climate risk, cat bonds have gained popularity within the finance sector and development finance institutions for use where public funds for rebuilding after a disaster are limited.

Cat bonds are primarily a form of insurance, but more specifically a type of structured debt instrument that includes insurance-linked securities (ILS). These are tradable assets tied to specialty capital markets and disaster risk designed to help insurers avoid bankruptcy from big payouts when disasters cause huge financial losses. Cat bonds are an innovative response to what are increasingly ‘uninsurable’ risks deemed too great for traditional insurance to cover, like wildfires, hurricanes, and earthquakes. 


Insured losses from intensifying impacts of climate change are indeed high and growing. Reinsurance firm Swiss Re reported $108 billion in insurance payouts for 2023 alone, and have predicted an annual 5-7% surge in insured losses globally due to the steadily increasing exposure of ‘high value’ areas to catastrophic risk.

Traditional insurance and ILS instruments both treat hazards as investment opportunities, creating new financial assets from disaster risk while setting terms for who is responsible and how compensation is paid. These instruments are meant to provide sustainable financing to mitigate stress on public resources after a major disaster. Like traditional insurance, cat bonds support reconstruction by distributing risk through ‘pooling’ to soften individual burdens. Unlike traditional insurance, which pools risk among policyholders, cat bonds transfer risk from governments and other entities to capital markets, spreading that risk—and its potential returns—across a broader base of investors.

The lion’s share of cat bond issuance is concentrated in the Global North, but the World Bank has created platforms available to its 189 member governments that directly issue cat bonds to cover major disaster risk and avoid “setbacks” in development. The World Bank’s cat bonds represent a significant portion of a global $7 billion cat bond market. Keeping with growth trends, the World Bank was sponsoring over $1.02 billion in cat bonds through its Capital-At-Risk Notes program by the beginning of 2024, and it intends to expand its reach over time.

How do cat bonds work? In Global Southern contexts, a government or entity issues a bond with a sponsor, commonly the World Bank and its reinsurance partners. Investors, usually hedge fund managers and private equity firms, buy these bonds, providing the fund that will be distributed to governments if disaster strikes. As with traditional insurance, sponsors receive premium payments over the life of the bond. But with cat bonds, investors also receive interest payments every quarter until they mature—usually over three to four years. If no qualifying disaster happens before that time, the principal is returned to investors in full, which along with regular interest payments offers an attractive return. But if a qualifying disaster does occur, the principal is paid out to the issuing government for reconstruction, and investors lose some or all of their investment, keeping only the interest payments they received up to that point.

Determining whether a disaster event ‘qualifies’ for a payout is an important part of how cat bonds are structured. Their design goes beyond the mechanics of traditional insurance to incorporate parametric models that use statistics to assess risks, define coverage areas, and determine the value of losses in specific places. With cat bonds, a payout is triggered when a pre-agreed upon threshold is reached—a 120 mile-per-hour hurricane windspeed or a magnitude 7.0 earthquake—which theoretically allows funds to be distributed more quickly since there's no need to wait for a damage assessment. Additionally, with this structure, investors in the cat bond know exactly how much they could lose because the payout amount is preemptively capped. This may seem complicated, but parametric criteria just limit who and what is covered by requiring a triggering event, which makes disasters less risky for investors than traditional insurance. Cat bonds also feature unusually high interest rates to compensate for the significant financial risk they present to bondholders. 

A 2007 New York Times article described this link between hazards, insurance, and capital markets as high-stakes gambling in nature’s casino where investors can diversify their portfolios and potentially earn high returns, but also risk significant losses. Winning the gamble with disaster risk is incredibly lucrative for investors, while losing offers potentially robust insurance coverage for poorer countries. This might sound like a win-win for everyone. Investors see it that way, but there is more to cat bonds than ‘resilient’ recovery.

Supporters of cat bonds say they are useful because they can handle risk coverage that regular insurance cannot: “We’re not profiting off destruction, we’re insuring destruction that is otherwise too large for traditional insurance companies to handle comfortably,” says John Seo, ILS and catastrophe risk industry expert, in a documentary about disaster capitalism. But in nature's casino, the deck is stacked in favor of the finance sector, where the institutional arrangements underpinning cat bonds are more invested in extraction and protection for the markets than they are for people and infrastructure.

One extractive pathway is the parametric criteria used to determine ‘qualifying’ disasters. These rules can make cat bonds less helpful in real-life situations. Unlike traditional insurance, cat bonds pay out immediately after a triggering event. This is made possible by replacing post-disaster risk assessment with parametric probability models—sometimes called cat-in-a-box models—that define a disaster as either inside or outside coverage parameters with no room for interpretation. These parameters are pre-agreed upon and tied to predetermined payout amounts. But in reality, the limits mean that cat bonds rarely pay out. Even a devastating disaster might not meet the specific parameters set by the model, which strictly defines the location, wind speed, intensity, or magnitude of a hazard, and ties these limits directly to pricing tiers.

A recent example of this can be seen in Acapulco, where Hurricane Otis hit Mexico’s coast with all the force of an unprecedented Category 5 in October 2023. Otis destroyed the city’s main shopping district, waterfront properties, and hundreds of informal residences, displacing thousands of families and causing over $5.7 billion in damage to public infrastructure and businesses. Mexico’s 2020 World Bank cat bond promised $125 million in coverage for Pacific storms—not even close to what is needed to reconstruct Acapulco—but after months of experts analyzing the hurricane’s wind speed and barometric pressure, the bond only paid out 50% of that amount for Otis, and Mexico did not earmark further funds in its budget for recovery. This is not an isolated incident. Similar non- and partial payouts have occurred in the Caribbean under other catastrophe insurance schemes (e.g., the Caribbean Catastrophe Risk Insurance Facility, or CCRIF), leading to skepticism and mistrust among some governments who had paid into a risk pool for years only to be hung out to dry in a crisis.

Another extraction pathway is the debt-dependence engendered by institutional arrangements around cat bonds and their construction. Cat bonds are debt-driven finance instruments, a pervasive feature of climate finance generally, which include green, sustainable, and blue bonds, blended finance, and debt-swaps. Tied to debt through premiums over a fixed maturation period, cat bonds increase dependence on external funding in Global Southern countries. Joint public and private finance approaches behind climate finance focus on narrow profit-making in the ‘now’ that hinders efforts to address underlying long-term issues. When it comes to recovery, the financialized risk structures behind cat bonds also favor debt-driven approaches that focus on immediate needs using short-term investment arrangements that prioritize immediate gains. These financial instruments also exacerbate instability by imposing lending conditions similar to 20th-century structural adjustment policies from institutions like the World Bank. This further embeds development finance and debt in the Global South, reinforcing the historical patterns of economic control and dependency.

The World Bank’s efforts to diversify its approach by combining access to multiple markets illustrates how these financialized risk structures are mediated by debt and development. For example, the Bank issued its largest single-country combined cat bond and swap transaction to date in 2023—a whopping $630 million in catastrophe insurance along with a ‘swap’ transaction worth $280 million to protect Chile against earthquakes and tsunamis. The World Bank was able to expand the value of the cat bond by marketing Chile’s risk across multiple markets, creating tension and maximizing the size of the bond. Transactions like these secure crucial financial protection for vulnerable regions while demonstrating development’s potential for leveraging capital markets and ensuring access to diversified portfolios for investors.

To the finance sector, the effectiveness of catastrophe insurance is less of a concern than the cat bonds’ outcomes for investors, indicating an instrument that primarily serves the interests of finance capital rather than people and infrastructure. In a recent industry report, cat bonds were shown to be an exponential growth market in the US and globally, one attractive to investors because disasters are made profitable through ILS. The same report says the quiet part out loud in reference to the US Atlantic hurricane market: “Of course, the concentrated exposure to US hurricane risk is exactly what many investors want from the catastrophe bond space." Meanwhile, where the bonds and state resources fail in the Global South, property and capital interests in post-disaster areas are secured through a combination of securitized humanitarian aid and increasingly military force. If what David Graeber calls the “marriage of interests between warriors and financiers” is the foundation of financial capitalism, the pairing of disaster risk and private capital in extractive, securitized contexts is foremost among disaster capitalism’s contemporary expressions.

There are new innovations emerging to address the limitations of cat bonds, including the use of generative artificial intelligence (AI) technologies as a solution to fixing discrepancies in simulating climate risk, one that is not without its own risks to the finance and insurance sectors. While reports of environmental degradation tied to the use of AI are rampant, there remains a growing interest among investors—and others who stand to profit from AI supremacy—in using generative AI for everything from education to energy. This includes predictive modeling, weather pattern analysis, risk assessment, infrastructure investment, large dataset interpretation, monitoring greenhouse gas emissions, adaptation and mitigation efforts, pricing catastrophe bonds, and analyzing climate finance markets.

Indeed, encouraged by excitement among some climate scientists and venture capitalists, many investors and insurance industry leaders are buying into the hype about AI innovations for cat bonds, arguably to de-risk insurance products and retain investors as risk becomes harder to predict in the face of the climate crisis. While generative AI may not actually decrease risk for cat bond investors or improve post-disaster outcomes, the emerging market that relentlessly pushes AI into the insurance sector and every corner of our lives is fueled by the same hubris around tech and startup culture that brought us cryptocurrency and ‘non-fungible tokens’ (NFTs). This in itself urges real skepticism and should be a warning that while AI is distracting, disaster risk is increasing, and all the wrong people are at the table.

The consequences can be devastating. The shift towards cat bonds represents a blatant new form of capital accumulation that exploits disaster risk in the Global South, where the World Bank facilitates access to global capital markets for the benefit of the North. The relationship between catastrophic climate risk and access to crucial climate finance in debt-ridden countries requires scrutiny, as these limitations date back to development interventions since Bretton Woods. In regions like Latin America, economic policies are deeply entangled with the fallout from World Bank and IMF structural adjustments and neoliberal reforms. That these same institutions and their methods now dominate climate finance and recovery resources in areas impacted by their past actions raises significant concerns about climate justice under current global political-economic conditions.

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