State Considers Bonds to Insure Against Natural Disasters

Taking earth-shaking measures against unpredictable devastation.

Israel is taking financial steps against the possibility of a devastating earthquake - one proposal is to issue catastrophe ("cat" ) bonds to cover the risk of major damage from a quake.

The final touches are being put in place by the National Economic Council, led by Prof. Eugene Kandel, and the Finance Ministry's Capital Markets, Insurance & Savings Division headed by Deputy Finance Minister Yitzhak Cohen.

The innovative bonds have become one of the most successful instruments in world capital markets. Considered relatively risky, they are sold at above-average yields. The risk for buyers is that the bonds default if a catastrophic event takes place. In such a case the money that the government raises changes from a loan to a grant.

The bonds are actually a way to buy insurance through the capital market. The state pays a premium in the form of regular interest payments and uses the principal as insurance against a pre-conditioned catastrophic event. If nothing happens the bonds are fully redeemable at maturity.

A strong earthquake could cause damage costing between $20 billion and $50 billion. Cat bonds are just one way to accumulate enough capital to deal with the financial repercussions. But there are differences of opinion between the Finance Ministry, the Bank of Israel and the National Economic Council.

The issue becomes entwined with the question of government revenues from natural gas discoveries. The best protection is a sovereign fund in which the country's surplus is put into long-term foreign investments. This has become a popular idea for the hotly-expected gas royalties as a way to share the wealth with future generations.

But the idea has its critics, in part because Israel is still saddled with a large national debt. What's the point in having long-term savings when you're carrying a huge debt?

Another reason is that the country already has a kind of national fund for its surpluses - the central bank's foreign currency reserves.

This money wasn't originally intended as a source for disaster funding. But it's basically a $70 billion savings account invested abroad and could cover all the country's needs - and more - in the event of a national crisis.

A compromise is probably in the making. A fund will likely be set up for financial contingencies. The fund will either be limited in size or begin accumulating only after Israel's debt-to-GDP ratio is lower.