Idea #12

Insuring Ecosystems to Ensure Climate Resilience

by Sarah Light and Carolyn Kousky

The natural world and its ecosystems are valuable both for their own sake and for the value they provide to people. These benefits people derive from nature are often referred to as ecosystem services.  An important class of benefits are those that help minimize the risks of natural disasters.  Coastal mangroves and coral reefs act as natural barriers that can protect coastal properties from storm surges that are reaching further inland as the sea rises (e.g., here). Wetlands reduce flood risk to nearby property, a risk that is increasing from an upsurge in heavier precipitation events. Vegetation on sloping lands can reduce the risk of landslides. These risk reduction services are becoming ever more important as the climate warms. Yet the ecosystems that provide these services are themselves under threat as a result of extreme weather events like hurricanes and storms.

A first-of-its-kind insurance policy was purchased this past spring to insure these important natural assets.  Off the coast of Quintana Roo, Mexico, a coral reef is both a tourist draw and an important coastal ecosystem that mitigates hurricane storm surges. In 2018, The Nature Conservancy signed an agreement with the Quintana Roo State Government in Mexico and the Cancun and Puerto Morales Hotel Owner’s Association to develop a Coastal Zone Management Trust to build “resilience” along the coastline. In partnership with Swiss Re, a global reinsurance firm, they developed a parametric insurance policy to protect the reef.  If a certain magnitude storm hits the coast, the policy would immediately pay funds to the Trust so they could begin restoration of the coral.  Scientists have found that if divers go in very quickly post-storm they can reattach coral and restore the reef (for example, see the coral restoration effort after the 2017 hurricanes here).  The insurance policy was purchased in June 2019 from a Mexican based insurer, Afirme Seguros Grupo Financiero SA de CV with a coverage limit of $3.8 million.

This novel example demonstrates the potential of innovative insurance policies to help in the restoration of natural systems that provide important risk reduction services. Insuring nature itself—by providing a specified payout to an entity with an insurance interest to restore a specific natural area such as a coral reef when it is damaged or degraded—can guarantee that the services nature provides are quickly restored in the event of damage from extreme weather events.

In the United States, some federal agencies will fund restoration of ecosystems if they are degraded or injured but this funding is tied to the whims of Congress and not guaranteed. Examples include dune restoration by the Bureau of Ocean Energy Management, the Emergency Forest Restoration Program in the U.S. Department of Agriculture, and select projects within the U.S. Army Corps of Engineers. Given that most of the funding comes in off-budget disaster supplemental spending bills, it often takes months or years for funds to be spent and projects completed (for example, disaster supplemental funding following the 2017 hurricanes took months and years to be appropriated). For communities that need protection restored quickly, or for ecosystems, such as coral reefs, where successful restoration is dependent on quick response, parametric insurance is superior to waiting for government action.

That said, there are a number of challenges with this approach which we explore in a forthcoming paper. First, in order to harness insurance, an entity with an insurable interest willing and able to pay the premium must be identified. For many ecosystems, their benefits are public goods, which means that it is not possible to exclude anyone from enjoying the good and also that as one person enjoys it that does not diminish the good for others.  For public goods, there is little financial incentive for a private company to supply them since they can’t capture any profits.  This could undermine the incentives for those with an insurable interest to pay the insurance premium.

Even those entities that would be financially impacted should the ecosystem be degraded may be unwilling to shoulder the cost of the premium alone. There are multiple examples of coordinating mechanisms and institutions that help overcome this challenge, including but not limited to government participation, and those would need to be used in this context, as well. Finally, insuring nature itself is not appropriate for all types of ecosystem protection. This method is ideal for systems in which there are restoration efforts that can be done to help the ecosystem recover. Further, to justify insurance, this restoration should require large sums, unlikely to be immediately available without insurance payouts, and should be cost-effective and add value beyond what the entity with an insured interest could do on its own.

So while not a silver bullet for ecosystem preservation in the face of climate change, insurance can be a powerful tool to fill a financing need not well addressed by other mechanisms.  The state of California is beginning to explore these and other innovate insurance approaches with the passage of SB30, which directs the state insurance commissioner to “identify, assess, and recommend risk transfer market mechanisms that, among other things, promote investment in natural infrastructure…”.  California has many ecosystems that can be threatened by extreme events, from coastal systems at risk of storms to forests at risk of wildfires, making it a natural place to pilot and refine this concept.

To further develop the viability of this concept, a nationwide study could identify those places that meet our criteria for when insuring nature may a useful tool:

  1. There is an ecosystem at risk of a natural disaster.
  2. An entity or group of entities benefits from the continued provision of ecosystem services from that system.
  3. Access to rapid funding post-disaster could finance restoration efforts, such as reattaching coral, reestablishing dunes, or planting samplings.
  4. Quick restoration would be difficult to self-fund.
  5. Beneficiaries can come together to overcome free-riding and collectively finance premium payments.

This post is based on a forthcoming article, Carolyn Kousky & Sarah E. Light, Insuring Nature, 69 Duke Law Journal (forthcoming Nov. 2019).

Sarah Light is Associate Professor of Legal Studies & Business Ethics at Wharton.

Carolyn Kousky is the Executive Director of the Wharton Risk Center.