WTW’s Simon Young on the role of parametric insurance in unlocking investments in ecosystem resilience

Parametric tools have a critical role to play in providing solutions to protect vulnerable communities and natural assets. Simon Young, senior director in the Climate and Resilience Hub at WTW, develops projects and programs around the world to build resilience to climate risk and natural disasters.

A major recent innovation led by Young was the development of a parametric “catastrophe wrapper” to provide cover for sovereign debt refinancing in Belize.

Below he outlines to The ESG Insurer the rationale behind the product, as well as highlighting other work in development at WTW to provide sovereign-level solutions.

Have you seen increased awareness of the importance of protecting natural assets in recent years, and is the insurance industry increasingly engaged in the development of solutions for these risks?

Yes, we’ve certainly seen an increase in interest and engagement from the insurance industry, particularly within the context of broader discussions around climate change and biodiversity loss, and the future inhabitability of planet Earth. COP26 in Glasgow brought climate and nature firmly together, so we only see the interest growing.

The industry writ large tends to take a longer-term view of the world, which provides a strong framework for considering long-term climate-related risk and reward (including physical, transition and legal), and P&C (re)insurers also understand very well, and see the impacts of, short-term changes in extremes as well as overall weather variability.

Applying these skillsets to the natural world is an obvious progression, to both better understand the risks, but also to help manage those risks, including through risk transfer mechanisms.

How does a parametric ‘catastrophe wrapper’ work?

In the Belize sovereign debt case, it was identified that hurricanes had the ability, demonstrated historically, to significantly impact the entire economy such that debt servicing becomes a short-term burden and the government may be faced with a choice of either defaulting on debt servicing payments or not meeting the immediate disaster response and early recovery needs of its population.

“Ex ante protection removes the need to choose, locking in the debt repayment and allowing the government to reallocate budget to response and early recovery”

A lot of progress has been made in making parametric products available to governments which provide quick funding for emergency response (for example., Belize purchases parametric cover from CCRIF SPC) – but debt servicing is a major budgetary responsibility for which specific parametric coverage has high value.

The Belize cat wrapper effectively pays the next debt servicing payment due after a hurricane (or succession of hurricanes) that meets fixed criteria (triggers), with the triggers designed to capture events which cause multiple tens of percent of GDP impact. The premium for this cover is embedded in the debt servicing payment schedule.

Why is ex ante protection of debt servicing obligations so important for vulnerable states?

Many of the most climate-vulnerable states are also the most indebted, and they increasingly find themselves between a rock and a hard place, having to make a choice, in the face of increasingly frequent and severe climate disaster impacts, between maintaining budgeted debt servicing payments and reallocating resources to emergency humanitarian response and early recovery.

We know from both theory and practice that what you can do with one dollar immediately after a disaster, to kick-start recovery, needs five to 10 dollars to achieve if the response is delayed by many weeks to a few months.

This means the right choice for both the short and long term is to invest in recovery, but a missed debt repayment often leads to higher borrowing costs, not just for the sovereign but for all borrowers, which hampers the longer-term recovery and sustained economic growth.

Ex ante protection removes the need to choose, locking in the debt repayment and allowing the government to reallocate budget to response and early recovery.

Could you outline some of the other parametric solutions WTW has developed to provide sovereign-level solutions?

Within the Climate and Resilience Hub, and working closely with colleagues in WTW’s Alternative Risk Transfer unit, we have worked with all of the existing sovereign risk pools in various roles from product development to operations support to risk transfer broking.

These pools – CCRIF SPC in the Caribbean and Central America, PCRIC in the Pacific, ARC Ltd in Africa and SEADRIF in Southeast Asia – cover a variety of perils (including cyclone, earthquake, extreme rainfall/flooding and drought) and around three dozen countries (with around 100 eligible to participate).

“We are actively working on a number of projects where we believe parametric insurance can be a key element of unlocking investments in ecosystem resilience, particularly where such ecosystem resilience directly enhances both dependent community resilience and biodiversity”

We’re also working currently with CAREC, an organisation comprising 11 Central Asian countries, to develop the framework for a risk pool in that region; we’re working closely with the Moroccan government to expand their catastrophe insurance program; we’re supporting work on parametric tools to manage sovereign flood and earthquake risk in a number of African countries; we’ve designed a sovereign-level parametric program for the government of Fiji; and have advised many island and coastal countries in and around the Caribbean Sea and the Pacific Ocean regarding sovereign-level parametric solutions for managing ecosystem risk and building resilience to climate change.

Finally, we’ve looked at potential parametric solutions at the sovereign level for such esoteric risks as volcanic eruptions, insect swarms and infectious disease outbreaks (which isn’t so esoteric these days).

How can these parametric tools help enable the transition towards net zero?

We’re still in the early stages of implementing parametric solutions to facilitate the transition to net zero. We do broker parametric solutions for renewable energy, particularly wind and solar, where production shortfall can be effectively hedged to meet reliability criteria and foster investment, and we see this as a major growth area.

And then on the carbon sequestration side, we’ve done a lot of innovative work, and implemented solutions, for wildfire risk to forestlands which, once de-risked, are much more attractive investment opportunities (given that wildfires both release sequestered carbon and degrade or destroy the sequestration source for a significant period of time).

And we’ve also been at the leading edge of developing solutions for protection of investments in coastal and marine (blue carbon) sequestration, again using parametric approaches.

The MAR Insurance Programme launched last year – what are the plans for the next phase of development for this initiative?

Under the existing funding from the InsuResilience Solutions Fund via KfW Development Bank, we are expanding the existing coverage for the 2022/23 period to include an additional three sites in Honduras and Guatemala.

We will also be stepping up our work with governments, other public sector institutions and the private sector, all of whom benefit from the services provided by the Mesoamerican Reef, to take on the premium funding and for broader support for the conservation and resilience agenda of the MAR Fund’s broader Reef Rescue Initiative.

Further, MAR Fund, in collaboration with WTW, has secured premium funding for one or more additional MAR sites, hopefully starting with the 2022/23 policy year, and MAR Fund and WTW are also collaborating with the Caribbean Biodiversity Fund to expand the program into the Greater Caribbean, with funding from the UK’s Blue Planet Fund, delivered through the Ocean Risk and Resilience Action Alliance, to undertake the foundational work in two or three countries which we anticipate will lead to further insurance coverages being in place later in 2022 or in 2023.

Are there other innovative tools in development through which parametric insurance can help both build resilience and enhance the transition towards net zero?

We are actively working on a number of projects where we believe parametric insurance can be a key element of unlocking investments in ecosystem resilience, particularly where such ecosystem resilience directly enhances both dependent community resilience and biodiversity.

Some of these projects also include development of carbon sequestration opportunities, particularly around mangrove protection/rejuvenation, but also coral reefs and salt marshes, and terrestrial forests too.

WTW’s approach is to demonstrate the value of insurance as part of a financing solution in practical ways, including ensuring that proceeds from any payout, for which premium needs to have been paid, are used efficiently and effectively.