S e c r e t a r í a d e H a c i e n d a y C r é d i t o P ú b l i c o Catastrophic Risk Management in Mexico Manuel Lobato Osorio February 2010

2 Mexico has a privileged position on earth. Among others, it is a natural hub for trade within the Americas. Its geographical position exposes it to several risks as earthquake, hurricane, and flood. Major historical earthquakes have been concentrated on the Pacific coast. Major historical earthquakes YearEpicenter Losses (mdd*) Magnitude (Richter scale) 1957Guerrero Michoacán1, Guerrero Puebla Oaxaca Colima Earthquakes *Million dollars of January 2010.

3 One of the most frequent risks in Mexico is hurricane; those phenomena generate significant losses in the Pacific and Atlantic coasts. The Atlantic coast is the one with the highest recurrence of events and significant losses. Major historical hurricanes observed in the last 20 years Hurricanes YearName Losses (mdd*) Central Pressure (mbar**) Máximum wind speed (Km/H) Category SS*** Atlantic Coast 1988Gilbert Pauline Ignacio Emily Wilma Pacific Coast 2001Juliette Isidore Kenna * Million dollars of January ** Milibar. ***Saffir Simpson

4 Fonden In 1996, in order to have a budgetary mechanism to protect against those and other risks, the Natural Disasters Fund (FONDEN) was approved in the Federal Budget. FONDEN’S main purpose is to provide support to federal agencies and local governments to attend the following main issues after a natural disaster has occurred: o Provision of first aid supplies. In order to attend the urgent needs of the population in the emergency zone (alimentation, medical attention, temporary shelter, people’s rescue from risk zones, among others). o Provide enough resources to reconstruction of the damaged Federal infrastructure, and of houses for low income population. FONDEN is also responsible for carrying out studies on risk management and contributing with the design of risk transfer instruments.

5 Fonden The structure of FONDEN has been designed to assist the population in emergency situations in an agile way. FONDEN is a trust managed by one of Mexico’s main development banks (Banobras). The structure of FONDEN includes a counterparty in each of the 32 Mexican states, including Mexico City, in order to facilitate the assignment and management of federal transfers. This structure main advantage is to provide resources in advance to state governments immediately, in average five days after the disaster.

6 Cat-Mex Mexico has continuously aimed at protecting FONDEN’S resources through new financial instruments. In this way, in May 2006, the Mexican Government subscribed the first catastrophic bond issuance in Latin America (“Cat Mex”). Cat Mex was a combination of a parametric reinsurance contract and a cat- bond with an insured amount of 290 and 160 million dollars respectively, covering earthquakes in specific zones of the Mexican territory.. The bond covered earthquake risk for three years. An insurance claim payment was triggered if: o There was an official state of emergency or state of disaster declaration issued by the Ministry of Interior, and o An earthquake occurs complying with the specified magnitude, depth and epicenter localization stated in the policy.

7 Cat-Mex The risk zones and the triggers were defined based on a risk analysis of the whole country. Zone A: Northwest Cocos Zone B: Central Cocos Zone C: Outer Mexico City TriggerZone AZone BZone C Magnitude (M w ) Richter Scale ≥8.0 ≥ 7.5 Max. Focal Depth (km)

8 Multi Cat Mexico 2009 In addition to earthquake coverage issued in 2006, and taking into account the need for protection against other risks, in 2007 Mexico began to analyze appropriate tools for hurricane risk transfer. In September 2007 the World Bank, through its Treasury, invited the Mexican government to participate in a Global Catastrophe Bond. This was an initiative arising from the bank to develop a financial protection scheme, based on natural disaster insurance for its member countries. The protection scheme would be such that, upon the occurrence of natural disaster, like earthquakes or hurricanes, and a low probability of a severe loss, Mexican government would receive a transfer from the financial markets.

9 Multi Cat Mexico 2009 In this sense, Mexico started working in 2008 with the World Bank (WB) in order to develop a financial mechanism to provide protection and resources for emergency care, after a hurricane or earthquake occurrence. The resulting mechanism was a catastrophic bond with coverage for three years. The mechanism continues the protection in case of an earthquake provided by the CatMex and broadens coverage to Pacific and Atlantic hurricanes. In order to determine the covered zones and triggers to be used, there were a thorough analysis of exposed zones in the country and a detailed modeling of the risks. Multi Cat Mexico (MultiCat) was issued in October 15 th, 2009, with a successful placement. The instrument was well received in financial markets, since it represented a good diversification opportunity for investors.

Multi Cat Mexico 2009-Eartquake 10 Cocos northwest area: magnitude ≥ 7.9 Richter scale. Depth 200 km. Cocos central zone (Guerrero and Oaxaca coasts): magnitude ≥ 8.0 Richter scale. Depth 200 km. Central zone: magnitude ≥ 7.4 on the Richter scale. Depth 200 km. MultiCat covers 3 zones against earthquake; the coverage amounts to 140 million. In comparison to CatMex, the zones and triggers in MultiCat improved protection for FONDEN. An insurance claim payment will be triggered when similar conditions as those in CatMex are met.

Multi Cat Mexico 2009-Hurricane 11 MultiCat provides financial protection against hurricanes in two of the highest-risk zones in the Pacific Coast and the riskiest zone in the Atlantic Coast. The coasts of Guerrero, Michoacan, Colima and Jalisco (Area C) and the coast of Sonora, Sinaloa and Baja California Sur (Area B) are covered against Category 4 hurricanes. The insured amount for each area is 50 million. In the Atlantic area, category 5 hurricanes are covered within the western part of the Yucatan Peninsula. The insured amount is 50 million.

12 Other projects Federal Government in Mexico keeps working on the development of projects related to catastrophic risk management, in order to protect FONDEN and the budget against natural disasters. Some of the main projects are: Definition of an insurance scheme to transfer the earthquake and hurricane hazards on Federal turnpikes, roads and bridges. Design of risk transfer schemes based on catastrophic bonds and parametric reinsurance, to protect housing for low-income people. Development of flood models in order to design prevention and mitigation plans in regions most likely to be affected by the phenomenon, and to define appropriate flooding risk transfer schemes.