Exploring the potential of insurance innovation to fund billions in nature-based climate solutions

 

January 13 - With some 55% of the world’s GDP either moderately or heavily dependent on nature, according to PwC
, much more finance needs to flow away from activities that harm nature towards activities that support it.

Indeed, the U.N. Environment Programme estimates  that annual investments in nature-based solutions (NbS) need to increase from $200 billion to $542 billion by 2030 to tackle the planet’s climate, biodiversity and land degradation crises.

One important channel could be voluntary carbon markets, with the World Economic Forum saying it could be worth between $5 billion and $30 billion per year by 2030, with perhaps two thirds of this channelled into nature-based solutions.

However, in the last three years, only 1.2% of the annual cost-effective potential of NbS has been unlocked by the voluntary carbon market, the WEF says.

One sector that could be key for expanding the voluntary carbon market and other forms of nature finance is the insurance industry, according to a recent report, opens new tab
 from insurer Howden and investment and advisory firm Pollination.

”The industry has a significant opportunity to scale and adapt existing products, as well as deliver new solutions, to drive a step-change in nature finance,” the report points out.

A hammerhead shark swims close to Wolf Island at Galapagos Marine Reserve, which is covered by Ecuador’s debt-for-nature swap. REUTERS/Jorge Silva Purchase Licensing Rights, opens new tab

”We need to unlock more finance to directly invest in nature restoration,” says Dr Carter Ingram, managing director at investment and advisory firm Pollination. The insurance industry ”can de-risk voluntary carbon markets and credits tied to NbS, and provide an incentive to restore or conserve nature by providing lower premiums if companies do so”.

She adds: ”About $7 trillion is invested in activities that degrade nature, so there is also a case for exploring where insurance incentives cause loss of nature today.”

Charlie Pool, head of carbon insurance at Howden, says insurers’ expertise in managing risk means they can de-risk projects and enhance governance, making ”the economics more attractive to people who want to find this space”.

Earlier this year Howden announced the placement of the first Carbon Credits Warranty and Indemnity (W&I) policy, which provides assurances that the buyers of carbon credits from a forestry project in Ghana can be compensated if social, environmental or financial issues arise that undermine the integrity of the credits.

Such assurances have enabled Mere Plantations, a UK-based company that owns and operates a teak plantation in Ghana, West Africa, to charge a premium for the credits.

Buyers can be confident that the company’s credits ”are legitimate, verified, and have delivered on their actual emissions removals,” says Mark Hogg, CEO of Mere Plantations. ”I am particularly excited to witness the positive impact this product will have and its role in reinstating confidence and integrity in the voluntary carbon market.”

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Water and nature-based solutions will be just as important as land-based projects, and insurance will be key to fulfilling the potential of the blue economy, says Lubomir Varbanov, head of public sector solutions at Swiss Re.

”Having robust insurance programmes in place helps to minimise the impact of adverse events on biodiversity, eco-services and related business activities. By sharing data, we can support deeper insights, product development and innovation.”

An example of this is China’s first Gross Ecosystem Product (GEP) insurance programme, which insured wetland carbon sinks at Hangzhou Bay National Wetland Park in the Ningbo region.

Swiss Re provided the risk platform that establishes how ecological products can help to mitigate the risks of major natural disasters, using agricultural risk model algorithms and big-data modelling.

”It’s a prime example of how the partnership between government, insurance, banking and wetland management helps achieve carbon neutrality goals,” Varbanov says.

Transferring the risk of projects can also significantly reduce transaction costs, boosting the efficiency of NbS. The government of Ecuador has led the way here with its pioneering debt-for-nature swap covering the Galapagos Islands, which are part of its territory and an important contributor to its economy as well as a globally important ecosystem.

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The deal deployed $656 million of private sector funding for marine conservation and eliminated $1 billion of foreign debt.

Several de-risking mechanisms were incorporated into the bond offer, including political risk insurance provided by the U.S. International Development Finance Corporation (DFC); reinsurance for half of the DFC’s commitment from 11 private insurance companies and a credit guarantee from the Inter-American Development Bank (IADB).

The combination of these solutions increased the credit rating of the bond issuance, in the process cutting Ecuador’s cost of borrowing by two-thirds.

Another emerging tool is parametric insurance, which pays out in the event of a natural disaster. The success of the world’s first insurance policy for a natural asset, the Mesoamerican Reef Insurance Programme, covering a reef system in the Caribbean Sea, has inspired other countries to look at similar solutions for reefs and mangroves.

The programme’s parametric insurance is triggered by weather events that reach an agreed level of severity for factors such as rainfall and wind speed. After Hurricane Lisa in 2022, the Mesoamerican Reef Fund received a $175,000 payout within two weeks of the storm to finance reef restoration activities.

In the same year, a coral reef insurance policy was developed for Hawaii, with a maximum payout of $2 million a year and $1 million per storm.

The advantage of parametric insurance is that it pays out rapidly on the basis of parameters related to the weather event, rather than by examining the damage done to the insured asset. That enables a rapid response after a storm, which increases the chances of restoring damaged corals.

Pool adds. ”Natural catastrophe insurance, often linked to technological solutions such as satellite and ground temperature monitors can help to increase investor appetite.” He points out that while insurers are starting to adapt existing products and design new ones for regenerative agriculture, coastal and forest systems, they can be challenging to price because nature and biodiversity is very localised.

”There’s obviously a big difference between a rainforest and the Arctic or a desert but, equally, two fields a mile apart in Oxfordshire can also be completely different,” he says.

Still, such products are developing fast and will continue to evolve. ”I have no idea what products will exist in a year’s time, but I can guarantee that there will be a new suite of products. Encouraging investment in nature is super critical. Insurers play a key role in making these markets investable.”