Likely end of Mexico’s natural disaster fund could bring opportunities
The fate of Mexico’s natural disaster fund FONDEN, the core funding mechanism used for reconstruction and recovery after major earthquakes in 2017, now depends on the senate, following the purge of 109 federally managed trust funds by the lower house.
Developed over decades under multiple administrations, the trusts on the chopping block include FONDEN as well others dedicated to a wide range of special purposes – including funds defending victims of human rights abuses, promoting rural development, helping returning migrants, as well as two funds that represent the backbone of Mexico’s independent film industry.
Weighing the prospect of FONDEN’s elimination, Eli Sánchez, associate director at insurance-focused ratings agency AM Best, told BNamericas he sees a potential opportunity for the risk industry should catastrophic coverage (CAT) against natural disasters move to a new scheme.
Sánchez said that under the legislation, “Each dependency will be responsible for mitigating its own CAT risks and that would be included in the [annual federal] budget.”
“This opens opportunities for primary insurers subject to their risk appetite and tolerances to participate in these risks,” said Sánchez. “Nevertheless, the willingness of the private sector to participate in governmental risks has seen a shift in recent years as the sector has experienced difficulties in pricing and collecting premiums and paying claims” within the current administration’s austere spending policies, he said.
The closing of the fund, said Sánchez, can only be carried out after fulfilling all of its legal obligations tied to the IBRD/FONDEN 2020 CAT bond -- the fund's sixth CAT bond issuance made in coordination with the World Bank and its International Bank for Reconstruction and Development (IBRD).
Issued in March, IBRD / FONDEN 2020 provides coverage on earthquakes and named storms for up to US$485mn, where GC Securities, Goldman Sachs and Swiss Re Capital Markets are joint structuring agents and joint bookrunners.
The 2020 issuance was also the world’s first CAT bond to mandate that proceeds from the sale be used by IBRD to finance sustainable development projects in its member countries – making it a hybrid catastrophe / sustainable development bond.
FONDEN is the ultimate insured along with its trustees, where trustees act as the insured for the coverage, entering into an insurance agreement with government-owned insurer Agroasemex.
“To buy back the CAT bonds would seem a difficult task, nevertheless we have seen the current administration incur high economic costs in order to implement its policies,” said Sánchez.
The administration of President Andrés Manuel López Obrador (AMLO) has come under heavy criticism for pushing ahead with the US$8bn Dos Bocas oil refinery project as well as other flagship infrastructure initiatives, including the Maya train project, while exercising restraint on fiscal measures to mitigate the coronavirus pandemic.
The government likewise incurred billions in losses with the cancellation of the partially completed international airport in Texcoco.
“This could also open opportunities for market participants to implement parametric contracts from the private sector hand in hand with multinational development institutions and the reinsurance market, but then again, willingness to insure risks might be the key factor looking forward,” Sánchez said.
“Alternative risk transfer in the region is not developed as it has only been used by sovereigns, nevertheless, this could open a whole new market,” said Sánchez, who added that it will ultimately come down to public policy and beyond that the risk appetite of market participants, including reinsurers, investors and multilaterals.
Sánchez said: “Uninsured public infrastructure can come at a high cost, as was the case with the Santiago subway after last year’s riots [in Chile], on the other hand, the benefits of insurance culture at a sovereign level have proven efficient,” as was Mexico’s experience with the 2017 quakes and Hurricane Patricia in 2015.
AMIS weighs in
Mexico’s insurer association (AMIS) also weighed in on the possible FONDEN elimination.
“The insurance sector is not directly affected by the disappearance of FONDEN, it is Mexico that is affected by the disappearance of FONDEN,” said AMIS general director Recaredo Arias in a virtual press conference.
“Obviously, every instrument can be perfected, nevertheless, what we have seen is reputable management at FONDEN,” said Arias, who added that the fund has undergone extensive external oversight of its bond issuances and its work has been supervised by Mexican development bank Banobras. Arias also underscored that the fund has won international praise, including from the OECD.
“We also believe that it will lose much of its effectiveness and be subject to many political pressures because the rules now will not be as clear and transparent,” said the AMIS head.
Fix instead of eliminate
While recognizing that problems exist with the trusts, critics of the legislation to axe FONDEN and other funds are urging legislators to improve them instead of an outright elimination.
“The drive for improved efficiency and transparency for those [trusts] that need it is better served by a review of their procedures,” read a statement from the Mexican finance executives’ association (IMEF).
“The cancellation will imply the loss of operating rules that were designed to carry out [each trust’s] purpose, and it will marginalize civil society participants that are experienced in the issues for which the trusts were created,” said IMEF.
Uncertain passage
The bill to eradicate FONDEN may fail to pass the senate or undergo significant changes even though AMLO’s Morena party holds a simple majority and the elimination of the trusts was a goal stated by the president early in the pandemic.
At least one key Morena lawmaker opposes the inclusion of FONDEN in the legislation: Eduardo Ramírez, who is a high-ranking member of the senate.
The legislation also faces the political opposition, made up by the PRI, PAN and PRD parties, as well as members of the labor party (PT) – one of three minor parties that usually vote in sync with Morena.
Lower house lawmakers led by Morena pushed the bill through Thursday after a 20-hour session, fending off attempts to break away various trusts through amendments.
It ostensibly aims to free up 68bn pesos (US$3.2bn) to help support the government’s pandemic efforts and balance the budget, and its supporters are rallying to the legislation citing a lack of transparency in the trusts as well as a multitude of irregularities found in audits for many of the trusts.
The federal auditing agency (ASF), for example, reported last year of irregular management of FONDEN funds designated for recovery efforts after the 2017 quakes.
The ASF review cited deficiencies in the application of funds allocated for job creation and public works on water, highway and educational infrastructure in the states of Oaxaca, Morelos and Chiapas.
An analysis of 15 ASF audits of FONDEN that was carried out by civil group México Evalúa estimated possible mismanagement worth 4.18bn pesos of the 17.8bn pesos it used with the quakes in question.
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