Figure 2: Proposed Structure for a Charity Catastrophe Bond
Charity CAT Bond Funds
If bond payment were not triggered during the life of the bond, then investors would regain their principal plus accumulated interest. The return on principal would be dependent upon the amount of charitable donations made to the fund. It should also be possible for the holding company to invest the CAT bond funds into short-term liquid investments, such as T- bills, that would provide a low, risk-free return in addition to the accumulated premiums.
Were a natural catastrophe to occur, a parametric index would indicate the amount of payment to be disbursed by the managing institution. Relief funds could be distributed through a variety of mechanisms. One option would be to establish a consortium of international relief organizations and local NGO’s that would receive the funds to be used in relief efforts within he affected country. Another option would be to disburse relief funds directly to the government to support government disaster assistance; however there would be legitimate concerns regarding equity and misuse of funds. Alternatively, the CAT bond funds could be filtered down through local organizations such as co-operatives or micro-finance institutions. This type of structure would enable local groups to offer insurance for smaller scale events by having access to relief funds for higher levels of loss though the CAT bond. In this situation, the charity CAT bond would provide a layer of reinsurance against aggregate losses.
The disbursement of funds would be pre-arranged so that payment would be immediately available following a catastrophic event. A third party financial institution could manage the bond funds and disbursement, to significantly lower the risk of misuse of funds and credit risk.