The economic power of Natural Capital is far reaching, but still underestimated under-used & under-priced. Why does investment in natural capital assets (like wetlands, rivers, reefs & forests) still struggle? Why do nature-based solutions take second place behind investment in energy and tech?
The core challenge is revenue...
The great challenge when it comes to financing natural capital is creating and embedding a strong revenue-centre that can support the key objectives and produce a return on investment. This is not to say that philanthropy cannot be used to help fund ecological restoration - but such efforts unfortunately have limited scope. Mobilisation at scale requires an incentive structure; and this means generating positive cashflow.
Financial services and sustainability professionals alike, have often struggled to make nat-cap projects financially self-sustaining. So is there a solution to this problem? How do we build a credible, cash-positive business model around a natural asset?
Revenue generated by tourism is often cited as one possible solution to fund ecosystem assets - particularly in areas of outstanding natural beauty. The preservation of coral reefs for example, is not only environmentally important, but vital to the future of local tourist economies. The most famous example, Australia’s great barrier reef, attracts around 5 million visitors annually; generating AUD 6 billion (USD 4.6 billion) in revenue each year. This does provide a clear economic incentive for preserving associated marine ecosystems. In this case the revenue challenge centres less on how to quantify the value of nature, and instead on how to pool or aggregate the interests of all the different stakeholders involved. However, we should be cautious using the Great Barrier Reef as our primary example. Many nat-cap challenges are more complex.
How do we make hidden-value visible?
In reality most ecological assets cannot rely on revenue from tourism. Not only is tourism usually seasonal in nature, but in many cases tourism itself exerts a destructive influence on the environment. The deeper issue however, is that most ecological assets don't make the spotlight at all. Ecosystems typically mediate value in subtle and/or circuitous ways that are virtually undetectable on the surface.
This is why we need strong, evidence-based, data-driven case studies that look beneath the surface and translate environmental impacts into economic metrics that markets can recognise. Value must be made visible. Markets need measurement… they need indicators, and they need benchmarks in order to assign prices, identify beneficiaries, and attract the funding necessary to mobilise projects at scale.
Natural capital meets... car insurance?
So do we have any case studies that shed light on the economic value-adds generated by natural capital? The answer is yes – and they are fascinating! We now know for example that strategic investment in natural ecosystems can have startling domino effects that generate economic value for the insurance sector.
Research just published by the US National Academy of Sciences (https://doi.org/10.1073/pnas.2023251118) reveals how the reintroduction of wolves to tracts of land in Wisconsin significantly altered the movement patterns of deer due to natural predation. This had the effect of driving a 24% reduction in road vehicle collisions with deer versus baseline levels. The associated economic benefit (aggregated across 29 counties) stands at $10.9 million per year. For context, that value-add is 63x greater than the verified costs of wolf predation on livestock.
So could we use the economic upside to drive a revenue model? A $10.9M reduction in vehicle collisions translates to obvious benefit for the car insurance sector. The business case would begin by providing costings for the managed reintroduction of wolves to the ecosystem, and then weigh those costs against the corresponding reduction in actuarial risk over time. The aggregate reduction in insurance claims translates to improved margins for insurers, lifting retained earnings and a driving concomitant increase in shareholder value. Once metrics are established and agreed for each link in the chain, a revenue model can be created whereby insurers fund the project, in order to reduce risk on their books and drive profit margins as a result.
Are there other examples?
This goes well beyond car insurance. Oregon State University recently published an extensive 13-year study (https://doi.org/10.1002/eco.2048) detailing how a similar reintroduction of wolf predation in Yellowstone National Park changed elk grazing patterns. The shift in grazing led to natural reforestation of waterways along the Beaverhead River. This in turn triggered a domino-effect that significantly reduced flooding along the river in southwest Montana. But how?
Shifts in the grazing patterns of elk led to the revegetation of streambanks, particularly by riparian willow trees. The improved foliage and canopy coverage facilitated a resurgent population of beavers which proliferated natural damns along the river. This, combined with improved rooting systems and hydrological storage has demonstrably served to attenuate peak water flows associated with high rainfall and snowmelt. The net consequence is that "frequent overbank flows onto the historical floodplain are now functionally absent”.
Again – we can derive an insurance based revenue model. Insurance companies profit on the differential between real-world pay-outs and the premium they charge. By reducing real-world flood frequency, that differential widens and profit margins improve. So here too, we have a potential funding mechanism whereby insurers may choose to remunerate natural capital projects in advance for eco-services which ultimately help improve their profit margins.
But it's all just theory... right?
The key question, is whether these proposed insurance mechanisms (or something similar) have ever been implemented commercially? Or is this a purely theoretical idea that proves unworkable in practice? Again – the answer is encouraging! We've selected 4 examples globally where insurance models of various descriptions have been used to support or finance nature-based solutions:
(1) RISCO Models
RISCO insurance models (Restoration Insurance Service Companies)¹ have run successful pilots in the Philippines that “conserve and restore mangrove forests by generating insurance-related revenue through property damage risk reduction”.
(2) The COAST Programme
In the Caribbean, the COAST programme (Caribbean Oceans and Aquaculture Sustainability Facility)² acts to develop climate-resilient sustainable fisheries (enhancing local economic and food security), and is financed through a series of parametric insurance products issued to the governments of Grenada and St Lucia.
(3) The R4 Rural Resilience Initiative
Looking to the public sector, the R4 Rural Resilience initiative³ incentivises the creation of natural capital through a series of IfA (Insurance-for-Assets) schemes that indemnify around 87,000 rural farmers against crop failures – in turn reducing their economic risks and helping them access credit that would not otherwise have been possible. This particular approach is novel in that it doesn’t rely on cash payments from farmers, but instead leverages financial inclusion to drive widespread economic development, increasing the size of the market in which insurers can operate. Everyone benefits as a result.
(4) NFIP run by FEMA
In the US also, the public sector is adopting insurance-like financing models. The NFIP (the National Flood Insurance Programme), run by FEMA in the US, helps reduces the economic impact of flooding by providing discounted insurance to property owners, renters and businesses in exchange for the implementation of various flood risk mitigation measures including wetland creation. This showcases a slightly different approach in so far as the taxpayer is substituting for role of insurer.
So what's next?
There is a long list of variations on this theme - but all share similar core features to the extent that natural capital eco-services reduce insurable risks in measurable ways. The prospect of improved insurance margins justifies the business case for funding or underwriting investment in nature-based solutions.
Despite all this, insurance based revenue models are not yet well known, and will require extensive collaboration between finance professionals on the one hand, and sustainability professionals on the other if we are to execute nat-cap projects successfully.
What are we doing?
ESG Oracle are collaborating with Keystone Impact Investments (KI) and a selection of other organisations, local authorities and nature/wildlife trusts across the UK to develop credible revenue centres that support the deployment of natural capital at both local and regional levels.
If your organisation has a mandate to develop/fund or invest in nature-based solutions - whether afforestation, river ecosystems, wetland creation, wildlife trails, flood mitigation or coastal protection - we would like to hear from you: firstname.lastname@example.org