Markets

Pandemic Bonds: What the WHO's Declaration Means for Investors

The World Health Organization declared Wednesday that the COVID-19 outbreak has now officially reached pandemic proportions, with people around the globe having contracted the virus. Although developed countries largely have the resources necessary to fight the disease, the same can't be said for poorer nations around the world.

In an effort to help those countries, the World Bank came up with an idea that would potentially channel much needed funding in the event of such an outbreak. Pandemic bonds are designed to make payments to poorer nations when an outbreak reaches certain criteria, with investors who bought the bonds essentially betting on such an event not happening. Although the WHO's declaration that the COVID-19 outbreak is officially a pandemic didn't in itself trigger payouts from the bonds, it now looks like a near certainty that the bonds will pay out to affected nations -- leaving some pandemic bondholders with huge losses.

The idea behind pandemic bonds

Historically, it's been difficult for the World Bank and other relief organizations to get funding to countries in need quickly. When a crisis occurs, organizations have to reach out to seek financial assistance, and governments are often slow to act and provide inadequate amounts of money to truly help.

Yellow-colored paper with word Bond highlighted.

Image source: Getty Images.

The World Bank decided that it would tap private investment in order to try to make relief efforts more efficient. In 2017, it issued two sets of pandemic bonds with slightly different provisions. Class A bonds with par value of $225 million paid a 6.9% interest rate -- far above regular interest rates for three-year debt at the time the bonds were issued -- but were designed to leave bondholders with nothing if 2,500 people died from a pandemic in a single country and at least 20 more deaths occurred in a different country. Class B bonds with par value of $95 million paid a higher 11.9% interest rate, but the triggering event required only 250 deaths from a pandemic illness, with scaled defaults that vary by how many countries worldwide see at least 20 fatalities from the outbreak.

Why haven't pandemic bonds paid out yet?

Many policymakers have criticized the World Bank's pandemic bonds. Under their provisions, the bonds haven't yet made any payouts to threatened countries, because their terms require a waiting period of 12 weeks from when the triggering outbreak began. With the coronavirus having first been reported toward the end of December, financial experts believe that a technical default won't happen until late March or early April.

That stands in stark contrast to what advocates expected the pandemic bonds to do. There was initially a belief that money would become rapidly available to countries early on in an outbreak. If the goal was to stop a disease from spreading to new countries, then time was of the essence in setting a triggering event -- and unnecessary delays are incredibly counterproductive.

How big will investors' losses be?

Under the terms of the facility, the most that the World Bank's pandemic bond program will pay through its so-called "insurance window" is about $196 million. A rating agency said earlier this month that it expects the payout from the bonds to come in closer to $133 million, although the mortality data on which it made its assessment has likely changed since then.

Many pandemic bond investors are also disappointed that the investments haven't provided any kind of diversification. One appeal of the bonds was the idea that they would perform much differently from more typical asset classes because of their link to catastrophic illnesses. Yet with stock markets falling sharply at the same time that these bonds will lose a lot of their value to bondholders, investors in pandemic bonds are getting hit from all sides.

Getting creative doesn't always work

On paper, the World Bank's efforts to come up with creative financing to help countries in need seemed laudable. Yet in practice, pandemic bonds haven't worked out the way many had hoped. It's likely that future pandemic bonds will get issued, but they might look a lot different from the current bonds.

10 stocks we like better than Walmart
When investing geniuses David and Tom Gardner have an investing tip, it can pay to listen. After all, the newsletter they have run for over a decade, Motley Fool Stock Advisor, has tripled the market.*

David and Tom just revealed what they believe are the ten best stocks for investors to buy right now... and Walmart wasn't one of them! That's right -- they think these 10 stocks are even better buys.

See the 10 stocks

Stock Advisor returns as of 2/1/20

The Motley Fool has a disclosure policy.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

Latest Markets Videos

    The Motley Fool

    Founded in 1993 in Alexandria, VA., by brothers David and Tom Gardner, The Motley Fool is a multimedia financial-services company dedicated to building the world's greatest investment community. Reaching millions of people each month through its website, books, newspaper column, radio show, television appearances, and subscription newsletter services, The Motley Fool champions shareholder values and advocates tirelessly for the individual investor. The company's name was taken from Shakespeare, whose wise fools both instructed and amused, and could speak the truth to the king -- without getting their heads lopped off.

    Learn More