Recognizing the fact that existing public law rules are insufficient to address the twin aims of preventing harm to ecosystems and quick restoration that we've identified, what I want to do now is turn to insurance which is not usually a tool in the ecosystem conservation universe, but I argue in a paper with Carolyn Kousky called Insuring Nature that it ought to play an increasingly significant role. The primary goal of insurance is to transfer or spread risk, and it can provide access to substantial capital in a disaster situation when such capital is most needed. But there are certain conditions of insurability, one condition is that the largest possible loss should not exceed the insurer's assets or capital. It is unlikely that an insurance company is going to write a policy to protect against the event of nuclear war. If there were a disaster in which everyone were harmed to essentially a complete loss this would likely exceed the insurer's assets or capital. Second, the average loss needs to be determinable and quantifiable so that it can be priced. If it's impossible to determine how large the average loss will be, an insurance company is not likely to provide a policy. Risks need also to be independent and not correlated; what does that mean? This is the idea that risk pooling is possible. If everyone suffers a loss at the same time this could bankrupt the insurer which would have to pay out all of the claims at the same time. An insurance contract also should not motivate policyholders to take an increased risk. This is what's known as moral hazard. An example of moral hazard would be the idea that, let's say I'm a driver and I get car insurance, as a result of knowing that if I get into a wreck from speeding my insurance is just going to cover it and it's going to repair the damage at very low cost to me. If I then decide to drive recklessly as a result of having an insurance policy, this is what's known as moral hazard. Insurance companies don't want to motivate policy holders to take an increased risk. Then finally a market must exist, it cannot be unraveled by what's known as adverse selection. Adverse selection arises as a result of the fact that the people or entities purchasing insurance know more about their risk than the insurance company. The concern would be that only high-risk individuals enter the pool. This was the motivation in the Affordable Care Act for the idea of the mandate that everyone must purchase insurance. The concern was that if only the sickest individuals purchase insurance this could lead to market unraveling. There are two primary insurance. The one that we're all most familiar with is what's known as indemnity-based insurance. Indemnity-based policies guarantee payment in an amount equal to the actual loss sustained. Car insurance and homeowners insurance generally are indemnity-based policies. Let's say my car gets into an accident or a tree falls on my house, in this case the insurance company would send a loss adjuster to my property to determine the amount of the damage and they would write a report evaluating and stating what the amount of the damage is and that would be the amount that's covered under the policy. As a result, the owner of the insurance policy, the insured, would receive an amount that accurately reflects the damage to the property, but this can sometimes be slow to pay out. There is however a second type of insurance policy that is called parametric insurance. A parametric insurance policy pays out the insured when a certain predefined triggering event occurs regardless of the actual level of loss. The trigger needs to be an objective measure of some disaster occurrence. This could be something like a wind speed in a particular location or the height of waters on a rivers flood gauge. These are objective facts that can be determined. Once that wind speed has been exceeded or the water height has been exceeded, the parametric policy will pay out an agreed upon amount of funding. Now parametric policies as a result can pay out much more quickly than indemnity-based policies. Essentially, once the trigger happens the policy should pay out, there's no need for a loss adjuster to come and visit the property. But unlike indemnity-based insurance, parametric policies are subject to what's known as basis risk. Basis risk is the idea that the payout will not match the actual damages. If the policy amount that is paid out when the wind speed exceeds a certain amount, if you underestimated what the damage would be and agreeing to the amount in the policy, there's the possibility that all of your loss simply won't be covered. How does insurance add value, again, bringing this back to the context of ecosystem services and climate change. Well, there are really two options. The first is using a standard insurance policy on property and providing financial incentives for ecosystem protection or restoration. For example, imagine that I'm a business owner, I could purchase property insurance. If there are ecosystems that provide protection to my insured property then the insurance company could charge me a lower premium for ensuring the protection of those ecosystems, whether that means a wetland or a coral reef etc. This creates incentives for me as the property owner to conserve and protect the ecosystem. There are examples of these financial incentives type programs to address climate risk; one is the firewalls program. The insurer, USAA, actually provides discounts on premiums to policyholders who live in communities that participate in the Firewise program. Participants in these communities have to undertake certain activities like landscaping that will reduce fire risk to their properties, therefore the insurer benefits because there's a reduced risk of fire and a reduced risk that they will have to pay out. What are some of the challenges of using standard property insurance and these financial incentives approaches to address the twin aims of preventing damage to ecosystems and ensuring quick restoration if they are damaged? Well, the big one is a mismatch in scale; what do I mean by this? Ecosystems don't necessarily exist only on a single property, they can be regional in nature, they can cross property lines, they can cross national boundaries or state boundaries. But insurance for property is generally purchased by an individual or a single firm. This can be problematic as a result if only some of the property owners engage in the incentivized activity to protect the ecosystem. One solution to this problem might be involving governments to address this problem and there are examples of government involvement in insurance programs, it's not always purely private. There are systems in which governments actually do mandate the purchase of insurance such as, for example, the National Flood Insurance Program. The second approach is the most innovative form of insurance and this is the idea of ensuring ecosystems directly. What do I mean by this? How is it possible that an insurance company could write a policy for a coral reef. Well, this has actually been done. The idea is that the policy covers a spatially delineated area against damage or degradation and the idea is that a parametric policy is used in order to ensure a quick restoration. In these cases insurance is possible even if no one owns the resource. What are the challenges with this approach? First, it's necessary to find an entity with an insurable risk that is willing and able to pay the premium to the insurance company. A second challenge is that the policy must be worth it to the entity purchasing the insurance policy. It has to add value. If it's actually quite inexpensive to restore a damaged ecosystem and the entity benefiting from the services provided by that ecosystem can simply pay out of pocket to restore it, it's not really worth it. The cost of restoration must be high enough to make it worth it to purchase an insurance policy. Finally, the insurance payout has to be quick. At least in the case of a coral reef restoration must be undertaken quickly, we can't be in a situation where we're waiting months or years, otherwise it doesn't really serve the purpose. There's actually an example of a parametric insurance policy for a coral reef in effect and it's under the auspices of the Mexican Coastal Zone Management Trust. The area that you can see in front of you and the picture on the left is an area near Cancun Mexico called Puerto Morelos. Scientists observed that when a number of intense hurricanes and storms hit Mexico that the area around Puerto Morelos suffered much less severe damage than many adjacent areas. As you can see the pink dotted line in that image on the left is a coral reef that protects the beaches. The images on the right are of the coral reef itself you can see that there is a series of hotels on the beach right at the shoreline and those hotels are there for tourists who want to visit the beach or even do snorkeling or scuba diving in the reef itself. Those hotel owners benefit in two ways from the coral reef; the first is when the coral reef provides aesthetic and recreational services to those visitors who then pay to stay at the hotels. Second, the coral reef acts, as we discussed, as a natural seawall to protect the upland properties against storm surges. The collaboration to create the Mexican Coastal Zone Management Trust began in late '80s. The Nature Conservancy observed based on its work in Mexico that there were significant damages as a result of a number of hurricanes. However, in 2009 The Nature Conservancy began its coastal resilience science and implementation on the coral reef in this are, and later in 2012 established a risk and resilience team that began exploring innovative policy and financial mechanisms to address coastal protection. In 2016 scientists working with The Nature Conservancy completed a study of the protective effect of this reef near Cancun and outside of Puerto Morelos, Mexico. The study determined that storm damages to the upland properties could possibly as much as triple if the reef are lost. As a result, The Nature Conservancy began to work with other key stakeholders including the government of the State of Quintana Roo, an insurance company called Swiss Re, and others to begin thinking about how to ensure the protection of this coral reef if it were damaged. How does the fund work? Key stakeholders including the State Government of Quintana Roo, Mexico, The Hotel Owners Association, The Nature Conservancy and the entity that manages the coral reef, The Reef Park, contribute funds into the Coastal Zone Management Trust. The Coastal Zone Management Trust then purchases a parametric insurance policy that's triggered by wind speed over a certain amount and objective trigger for the policy. If the policy level isn't triggered the Coastal Zone Management Trust can act as a self-insure, the funds in the trust can be used to do lower-level restoration of the coral reef if needed. This insurance policy is actually in effect as of June 1st, 2019. A local insurance company has written this policy, the beneficiary is the Mexican Coastal Zone Management Trust and the assets that are covered by the policy are the reef and the beach. Because it's a parametric policy, again there's a payout limit that is agreed to and that amount is $3.8 million. The payout structure depends entirely on the wind speed. If the wind speed near the reef and beach ranged from 100 knots to 129 knots 40 percent of the payout is provided. If the wind speed is between 130-159 knots, there's an 80 percent payout. If the wind speed exceeds 160 knots to 100 percent of that $3.8 million is paid out. There are teams of experts in reef restoration known as Brigodores, who stand at the ready to reattach coral in the event that the coral reef has been damaged. The quick payout is really essential here. What are the value and values that insurance ads in this context that other tools like the public law statutes I reviewed earlier can't provide? On the positive side insurance provides a tremendous amount of transparency, accountability, and speed. There's no need to wait for the ledgers of government to say, "Oh my, the coral reef has been damaged, we need to appropriate funds to protect it?" Instead, there's a guaranteed payout triggered by objective measures that can be speedy, this is all public information and so everyone in the community knows precisely how much money will be paid out when these objective triggers are reached. In addition, insurance can provide positive transnational impacts. I talked earlier about the idea of mismatched scale where individuals or business firms can purchase insurance policies that cover their property, but ecosystem sometimes span many properties. In this case, imagine that the coral reefs spans the border between the United States and Mexico, it would still be possible for entities on either side of the border to collaborate and purchase a parametric insurance policy. Insurance definitely provides value in the twin aims of reducing harm and providing funding for quick restoration. There are however other values to consider. On the notion of what's called environmental justice, thinking about the distributive impacts of environmental benefits and harms. This insurance policy needs to be purchased by someone and it needs to be purchased by someone or something or some group of someone's who have the means to purchase an insurance policy, so only those who are willing to pay for an insurance policy are able to benefit in some sense from the parametric insurance for nature model. On the flip side however, remember coral reefs and other ecosystems are public goods so it is entirely possible that that coral reef which is being protected by an insurance policy purchased by a group of hotels as well as government actors is actually providing protection to other a plan properties owned by those who are unable to purchase an insurance policy themselves. Finally, I want to make one note of the idea of expressive content; so what does expressive content? It's the idea that insurance for nature arguably is providing some expression of support that nature itself deserves to be protected and not just private property. On the flip side when we think about ecosystem services, ecosystem services has a concept is anthropocentric in nature. It's not entirely about nature as an end in itself but also about nature as a means to an end of human benefit. The key value of insurance in this context really is the transparency, accountability, speed, and potential for transnational impacts. On some other values its impact may be more mixed. This raises the question, if there's one insurance policy out there for coral reef; is this a model that's actually generalizable? My co-author Carolyn Kousky and I, and our paper argue that this is a generalizable model but that there are five key factors that need to be in place in order for this to generalize. The first is that there's actually an ecosystem that's at risk of a natural disaster and the natural disaster has to be something that is insurable, meaning there has to be a risk of harm and not a certainty of harm. No insurance company is going to write a policy if the harm is certain for anything less than the full cost that they will ultimately have to pay out. There has to be a risk and not a certainty. Second, there actually needs to be an entity or group of entities that benefits from the continued provision of ecosystem services from that system, so in the case of the Mexican Coastal Zone Management Trust the The Hotel Owners Association obviously benefit from the protection of the coral reef as well as from having a healthy coral reef in the first place that is why they were willing to contribute to paying the premium. Third, access to rapid funding after a disaster could actually finance restoration efforts. When we're talking about a coral reef, a coral reef can have damaged coral be reattached in other cases we can think about planting saplings after a forest fire or re-establishing dunes that had been damaged by coastal storm surge but, not every ecosystem is capable of rapid restoration. The fourth point is that quick restoration would actually be difficult to self-fund, so it has to be sufficiently expensive for the insurance policy to be worth it. Finally, beneficiaries are going to need to come together to overcome free riding problems in order to collectively finance premium payments. This suggests that in some cases a government entity may be needed in order to overcome the collective action problem just as in the case of the Mexican Coastal Zone Management Trust where the state within Mexico of Quintana Roo government participated in the creation of the trust in order to help overcome these collective action and free riding problems. Other potential applications of insurance for nature include protection of forests after wildfires, dune restoration, and protection of certain ecosystems after earthquakes. I'd like to leave you with four key takeaways in Module 3. The first key takeaway is that business leaders need to think not only about mitigation but also about climate resilience and what you all or they all can do to promote climate resilience. Second, ecosystem services provide essential climate resilience. We need to be thinking about green infrastructure and not just gray infrastructure. Third, one specific tool that I've gone into detail on today private insurance can add value to the protection of ecosystem services particularly in the climate context. Finally, I'd like to leave you with the broad point that business leaders need to be thinking creatively and collaboratively about climate solutions.
