Arjun Goyal, World
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Pandemic Bonds: Could this be a Financial Vaccine?

By: Arjun Goyal

The World Bank tried to tackle slow funding of Ebola hit countries by introducing contingent securities called Pandemic Bonds. But this may have caused more problems than solutions.

Back in 2014, West Africa was in the grips of a widespread, fast-growing epidemic: Ebola. As the world watched on in horror, the disease claimed more than 10,000 lives in the region between 2014 and 2016. Countries like the United States and many others pledged to help assist the impoverished West-African states of Congo, Sierra Leone and Guinea (among others) by providing donations. Some of these countries came together to provide a lifeline of close to $100 million through organizations like the Red Cross Federation. With these resources and countless hours of work by nurses and doctors, the affected regions experienced some respite. While Red Cross could be seen as a saving grace by pulling these funds together, there are portions of the story that have fallen through the cracks. In 2017, the Red Cross came out and apologized for being unable to allocate $5 million of the donations to the unaffected regions. Why? Fraud. A sum of money that may have helped save families suffering from the abominable disease simply vanished into thin air between overpriced supplies, salaries for workers that do not exist, and fake customs bills. 

It seems shocking, and to an extent infuriating, that the world’s best known humanitarian organization suffered such a snafu. After all, isn’t allocating funds from donors to affected regions their job? But misallocation of funds in humanitarian operations is widespread. Haiti, Yemen, Sierra Leone and countless others have suffered at such corruption’s hands. What is more concerning is that even without corruption, funds are simply not reaching the places they need to in time. In 2016, funds only reached affected areas three months after they were requested. For a disease that can incubate for as little as 2 days and claim lives in even 6 days, this is simply not good enough.

This problem is widely recognized in the international humanitarian community, and the World Bank’s responded to this by creating a financial instrument called the ‘Pandemic Bond’.

Those uninitiated in fixed income markets may find it difficult to understand the process and rationale behind pandemic bonds if they were to simply look at the World Bank’s PEFF prospectus. From the perspective of a bank representative trying desperately to get you to invest, here’s a simple overview.

If you are an investor looking to park your money in an asset and generate some return from doing so, you can put it in a savings account or term deposit and earn some return completely risk free. However, if this return is not much, you may want to take some more risk and put this money in an asset that gives a higher return. Here’s where Pandemic Bonds can be an option for you.

Pandemic bonds give you a very attractive return, sometimes more than 11% per year. You may get these returns by putting your money in stocks, but that won’t give you fixed payments periodically (a key feature that makes bonds popular investments). What’s the catch, you may ask. If there is an unfortunate occurrence of an epidemic in one of the affected areas, and the epidemic meets the requirements of the World Bank, a portion of the principal invested by you will be allocated to the affected areas immediately. This means that this portion of funds would not be returned to you, as an investor, at maturity.

To demonstrate this, if you invest $100 in pandemic bonds for 10 years, with a coupon (or rate of return assuming you do not sell this bond before maturity) of 11%, you would receive $11 every year for 10 years and then your $100 at the end of 10 years, only if there is no epidemic outbreak that meets the requirements of the bond. However, if there is an outbreak, and 80% of the total invested amount is required for combatting this, you would stop receiving your coupons and only receive $20 back ($80 are used to fight Ebola, SARS or other horrible diseases). So yes, you get enormous returns compared to the rest of the market, but there is a chance that you may not receive your money back at all.

At a glance, this may seem like a bad deal. You may receive high returns, but there is a chance that you may lose almost everything you put in! However, the real investors into these securities use statistical models to estimate whether this is a good investment or not. I sat down with Professor Carpenter, who teaches Fixed Income Instruments at New York University, to understand how someone trying to invest in this would estimate whether to invest or not.

After a series of bond math and binomial trees (and a brief moment of complete confusion at Professor Carpenter’s derivation in my head), she derived that at a simplified level, an investor would want to invest in pandemic bonds if the coupon rate on these bonds follow the following equation:

Coupon ≥ Required Return + λ, where λ=probability of an outbreak in a year

I have to caveat that there are a number of simplifications in this model (those not interested in statistics can ignore this portion). We assume that every year has the same likelihood of an outbreak occurring (which may not be true) and that these probabilities are discrete rather than continuous. She also noted that the model assumes no money being returned in case of an outbreak (100% allocation to combat the disease).

While these assumptions make this model inappropriate to use to make an investment decision (a more accurate one would need a lot more variables and data analysis), it shines a light on an important truth: this is a pretty good deal. Rates in fixed income instruments are dropping as governments around the world cut rates, and bond investors are searching for high yield bonds (they have been given the moniker “yield hunters”). Consequently, required rates of returns have been forced to drop. With these low required returns, and preventive efforts from the WHO to prevent these diseases, pandemic bonds are extremely attractive assets to bond investors. Pandemic bonds become even more attractive when it is extremely unlikely that the entire investment base would be required to battle the disease. This is why the first bond sale in 2017 was heavily oversubscribed (investors wanted to invest more money than bond principals available) and collected close to $320 million. Asset managers, pension companies and other institutional investors have lapped up these instruments, since it not only gives them returns but also helps with their CSR (Corporate Social Responsibility) goals.

At this point, pandemic bonds seem to be genius. They could be modeled not just for epidemics, but for other socially conscious uses too (catastrophe bonds have existed for a while now to provide relief to natural disaster hit areas). However, when the 2019 Ebola crisis hit DR Congo, pandemic bond champions were stung by the harsh realization of a key problem.

Remember back when we were discussing what a pandemic bond was, I mentioned that the bond pays out to affected area if the epidemic meets the requirements. It turns out that this is a big if. To make sure that investors buy these bonds, the World Bank had to create a very strict definition of what constitutes an epidemic, in relation to this bond. How specific are these requirements? The original bond stipulated $45 million being deployed if there are 250 confirmed deaths from the disease, but at least 20 of these have to be in a second country. So when the Democratic Republic Congo suffered the Ebola outbreak and breached this death rate, they did not receive any funding from these bonds because there weren’t 20 deaths in a second country. In fact, it seems unlikely that this cash would ever be deployed because the countries surrounding it aren’t nearly as populated as the DRC.

Essentially, the World Bank is waiting for the disease to spread and cause more fatalities so that it can allocate these funds. This is not just a villainous idea, but counter to the purpose of these instruments. Investors have cashed out on millions, while West Africa waits for their lifeline. The World Bank has faced extensive backlash from critics regarding this. Olga Jonas, an economic advisor at the Harvard Global Health Institute and ex-World Banker, stated that “It was a good deal for investors, not for global health. Absurdly, discussions on a second PEF are under way.”

My opinion on pandemic bonds is not as harsh as Jonas’. At heart, pandemic bonds are an attempt to tackle inefficient and sluggish mobilization of funds to help stop epidemics at the door and turn them the other way. Simultaneously, the World Bank has to set caveats to the bond that are stringent enough to attract investors and appeal to their risk appetites. The line between these two spheres is thin. But I think as a first iteration of an ESG asset class, pandemic bonds have a lot of room to grow. If epidemics can be modeled more accurately and middle ground be found between risk appetite and humanitarian benefit, pandemic bonds can soon be the first responder to these catastrophes, and may eventually replace humanitarian donations altogether. It’s clear that there is a huge market for these instruments, and with ESG having an increasingly large focus in the corporate space, there will only be more investors. My hope is that the next iteration will prove critics wrong, and fast-track resources to those in need if the situation arises.


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