Give Pandemic Bonds a Chance


(Bloomberg Opinion) -- Pandemic bonds can’t catch a break. These securities offer relatively high rates of interest to investors unless the risk of global pandemic rises beyond specified trigger points, in which case investors lose some or all of their capital. When the World Bank issued $425 million of these bonds in 2017, there was widespread skepticism among public health professionals. Many called it a publicity stunt that diverted scarce healthcare dollars to financial markets.

Then in 2018, the bonds weren’t triggered during the Ebola outbreak in the Congo, and critics denounced the bonds as giveaways to the rich. Now in 2020 with the coronavirus hitting trigger points, people are complaining that the bonds are not only toxic to investors, but the money they raised is too little, and being released too late, to be effective.

In fact, pandemic bonds are precisely the right solution for two big problems: funding a pandemic threat response and improving the financial health of underfunded pension plans. Moreover, the underlying concept may be our best path to a peaceful, secure, prosperous future by turning the fragility of society in the face of large disasters into something more sturdy.

The first level of defense against pandemics is local health services and public health reporting. These are how threats are identified. Since costs are recurring and insurance and funding mechanisms are well-established, there’s no need for novel financing vehicles.
The second level begins when an outbreak poses a non-negligible threat to global public health. Pandemics causing hundreds of millions of deaths and trillions of dollars of economic damage are not implausible, so even a 1% or 0.1% probability can be worth spending billions of dollars to mitigate.

But time is of the essence. Dollars must pour in for containment, study of transmission, and development of tests, therapies and vaccines in a short time window before the spread becomes uncontrolled.

In some cases, such as with severe acute respiratory syndrome, or SARS, the second level ends the threat. In other cases, such as AIDS, the syndrome becomes a long-term public health issue. In either case, there is no longer a need for specific financing vehicles. 
Second-level funding is not humanitarian aid, it’s the self-interest of donors protecting their lives and property. Therefore, it is wrong to try to fund it out of humanitarian public health funds. Moreover, there isn’t enough money in annual international public health budgets, and starving public health in areas away from the threat is clearly foolish.

Wealthy countries and private organizations do promise to provide second-level aid, but getting actual cash can be too slow and uncertain. Disbursement will depend more on political considerations than public health ones, and public health officials will be chasing dollars when their attention is desperately needed on fighting pandemic. Sadly, there is much corruption in the process, and too many dollars disappear or are diverted to unrelated projects.

Wealthy countries and donors could create a reserve fund to make the money available faster and with more certainty. This is done to some extent. The big problem here is replenishment. Once the money is used, it could take many years to build the fund up again. The great thing about pandemic bonds is you can sell more of the securities in order to raise cash even before the old bonds are triggered. There’s no need for gaps in funding.

Pandemic bonds also address a glaring need among pension funds for investments with returns above the risk-free rate -- which is low everywhere and negative in some places -- that are uncorrelated with major financial markets. Due to the chronic underfunding of pensions and healthcare promises throughout the developed world, funds must choose between investments certain to fall short of future needs or taking levels of risk that could cripple the plans beyond hope of recovery in a major downturn.

Some have challenged claims that pandemic bonds lack correlation, noting that global pandemic threats hurt equity returns. This is true, but quantitatively negligible. What matters isn’t how consistently equities react to pandemic news, but what fraction of equity volatility is explained by pandemics. That’s essentially zero.

What’s true of pandemics is equally true of other natural and human-made disasters. No one knows the probability of some kind of mass disaster—pandemic, war, asteroid impact, nuclear meltdown, genetically engineered debacle, behavioral mass killing (e.g. tobacco smoking), mass volcano eruptions or earthquakes, climate-change disaster, whatever—but it certainly could be in the 1% to 10% range over the next few decades. Some seem to think it’s near 100%, but we generally act collectively as if it’s zero.

Disasters make civilizations fragile; they can destroy societies. But people coming together to guard against disasters, and pitching in to help out afterward, builds civilizations. Ethnic and class hatreds are irrelevant, disasters can touch everyone equally. Therefore, rational planning about disasters can make civilization anti-fragile.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Aaron Brown is a former managing director and head of financial market research at AQR Capital Management. He is the author of "The Poker Face of Wall Street." He may have a stake in the areas he writes about.

©2020 Bloomberg L.P.

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