Insuring against failure

With Rio+20 about to open I have to give a shout out to the idea of iREDD advanced by Corey Bradshaw et al. They propose to address some of the major challenges of REDD by requiring sellers of REDD credits to purchase insurance (that oh-so-cool i on the front of iREDD). One very good point in its favour is that this should massively increase the buyers’ confidence, although, it should be noted that voluntary carbon market standards such as VCS already require project developers to retain substantial buffers of carbon offsets for just such an eventuality. However, I think financial insurance is a stronger option, since one catastrophe – e.g. a massive forest fire – could wipe out a project’s entire carbon achievements with no recourse. Insurance provided by a highly capitalised third party delivers much better cover for such events.

Thus insurance appears a very good way of dealing with the problem of permanence. It should also be fairly easy; there are pretty good data available on wild fires, whilst forest owners who themselves cleared the forest (or allowed someone else to do so) would be guilty of insurance fraud. (Following the logic of my post yesterday, insurers would probably also have to consider political risk, in which the forest owner suddenly finds they are no longer the forest owner.)

But in tackling the other challenges in REDD in demonstrably delivering real net additional reductions in carbon emissions (see here for my previous observations) iREDD seems mostly just to come down to the idea of insuring against the risk that a proposed action does not result in the desired outcome. Here I see a much greater challenge for insurers. How should they quantify such risks? Every project will be unique in some way or another. I foresee great difficulties in developing standard metrics by which these things can be assessed, and where such guidelines could be determined I fear they would tend to favour cookie-cutter style projects and incentivise against innovation.

On the other hand, if these hurdles could be overcome, this seems to me like an idea that has great potential way beyond the REDD arena. How about if donors required every aid project except for the riskiest (which would therefore obviously stand out) to obtain such insurance? That would force project developers to confront major operational risks in a much more explicit manner than at present. Furthermore it could open up innovative approaches to project funding (donors would expect to get some of their money back when projects fail), and could allow private sector operators taking a greater responsibility for the entire project cycle and assumption of risk. This would be in contrast to the current model for involving the private sector in which big consultancies make fat profits for running flawed projects designed by a donor who should have but didn’t know any better.

Owen Barder recently blogged about attempts to extend the still experimental idea of Social Impact Bonds into the international development space*. These also invite private sector players to assume some of the risk of delivery. Insuring projects against failure could be another option to add into the mix.

In practice I can see that it is going to take quite a while for these various different instruments to be put into practice, during which time we can hope – indeed reasonably expect! – that significant numbers of poor people and poor countries will have developed to the point where they are rather less poor and less in need of development assistance. But that could also work in these ideas’ favour: the least developed countries have the least capacity to engage in these kind of risk-sharing models involving the private sector.

So all in all I think it is great to see innovative thinking around conservation and development finance, and I hope that at least some can come to serious fruition. And I look forward to one day filling out an insurance registration for a project I have helped design!

* The various comments echo my points above about some of the practical challenges that would need to be overcome to introduce these as financial instruments worthy of the name.

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