Figure 1: Probability Distribution Function for Covariant Losses
Disaster Losses ($)
For poor countries that are vulnerable to large losses from natural disasters, small nations in particular, a charity catastrophe bond could provide additional capital for disaster relief efforts. This source of contingent capital could be structured to encourage more efficient use of disaster relief funds through ex ante planning, access to unconditional capital, and objective means of allocation.
Existing catastrophe bonds could be designed to provide a source of contingent capital for developing countries following a natural disaster. This external funding would provide resources for disaster relief and recovery in such a way that could overcome some of the limitations of traditional sources of disaster aid. Furthermore, removing the catastrophe exposure in LMIC would open the door for the development of formal insurance sectors for managing more frequent, independent risks. As these markets emerge, financing of catastrophe risk can be more fully internalized.
A charity CAT bond would be structured similarly to existing commercial CAT bonds. The main difference is in the objective. Similar to a reinsurance contract, a charity CAT bond would guarantee a pre-determined payment of money contingent upon the occurrence of a pre- specified natural disaster. In this situation, however, the financing would come from bond investors while the premiums would accumulate from charitable donations. A charity CAT bond would leverage contributions to disaster relief by promoting more efficient use of disaster relief funds while generating returns that could increase the amount of available funds in the event of a natural disaster. In the absence of a disaster, the investor would experience a return on their investment.
Recently, increased attention has been given to researching alternative applications for CAT bonds in developing countries. Based on the difficulties LMIC have financing disaster