ARAB REINSURANCE COMPANY

Establishing a Green Fund In the Mena region

Basma Barakat – AGM Technical

10/7/2012

Is there a need for a special green fund to be set up to help industry cope with the challenges of global warming?

Introduction: Elbert Hubbard (American writer 1856-1915) once said “Everything comes too late for those who only

wait”.

With this quote in mind, the time for taking critical steps towards mitigating global warming is now. We see signs of imminent catastrophes all around us, driven by the perils of environmental abuse. As national representatives and the leaders from the business community worldwide exit the stage from the Rio+20 Conference, now is the time to set up a ‘green fund’ in the MENA region. Now is time to take environmental concerns seriously, and to make significant steps towards meeting sustainable development targets. Sustainable development simply means how we, as a human race, can sustain the existence of natural resource in order for the current and future generation to survive.

The General Assembly of the Rio+20 Conference focused on two themes: (1) a green economy in the context of sustainable development and poverty eradication; and (2) the institutional framework for sustainable development.1

While different countries may not share the same approach, the objective remains the same: how do we

encourage sustainable development through more efficient use of natural resources while ensuring that

poverty will be eradicated? Although we refrain from putting too much hope in any single solution, or

treat initiatives as panaceas, a green fund can be instrumental in tackling some of these issues.

Another challenge we are facing, which is directly affecting the insurance industry, is increased weather-

related losses from natural disasters (see Figure 1 below). These hazards include rising sea levels that

will impact major coastal cities along with severe floods, and increased droughts and forest fires. Insofar

as scientific evidence is concerned, we cannot clearly and totally attribute these losses to human-caused

climate change; however, it is evident that inflation-adjusted insured damages from natural disasters

will increase as the world becomes wealthier and risks become more widespread (Barthel and

Neumayer 2012).

Hence, ongoing research efforts are much needed for developing incentives to encourage more

environmental stewardship for land managers. Land-use decisions that resulting in deforestation (e.g. in

this case, removing trees to have a larger area to plant vegetation and agricultural produce) and

inappropriate land-use strategies have significant impacts on ecosystem services – or the stream of vital

benefits to society from nature – at the global level.

1 http://www.uncsd2012.org/objectiveandthemes.html

While it is clear that industry and the transportation sector have responsibilities towards mitigating their

carbon footprints, attention here is paid to how green funds can potentially help reduce greenhouse

gases (GHGs) emissions from land-use practices, while increasing ecosystem services through more

sustainable measures, focusing on the MENA region.

Figure 1: Trends in natural disasters worldwide - Courtesy of Munich RE

The purpose of a green fund and how would it be established? Twenty years following the groundbreaking UNCED Earth Summit in Rio, which served as a benchmark

for designating sustainable development and environmental protection measures globally, our

governments have largely failed at meeting the proposed targets set therein. However, the private

sector has made some positive steps in acknowledging that they also have a critical role to play in saving

our planet. Indeed, this is more promising than the lowered expectations of accountability,

responsibility and political will coming from our world leaders.

Over 30 major multinational corporations have become signatories of the Natural Capital Declaration

that emerged from the Rio+20 talks2. This move has signaled what is indeed becoming a major concern

over the risks faced by the global business community in this era of global warming, climate change and

environmental degradation. These novel investments, akin to ‘green funds’, are aimed at boosting an

emerging and much-needed green economy sector. This sector should inherently encourage more

innovative goods and services in order to meet the demands of environmental protection and

sustainable development.

Another major outcome from the talks is an alliance of insurance and reinsurance companies that have

initiated the Principles of Sustainable Insurance (PSI)3. Nearly 30 companies in this sector are

representing “the first-ever global sustainability framework tailored for the insurance industry that takes

into account the fundamental economic value of natural capital, social capital, and good governance”4.

The purpose for establishing green funds globally are being echoed by numerous CEOs and company

representatives in the private sector – our global economy is dependent on the resilience of our Earth’s

ecosystems for provisioning natural resource, i.e. natural capital.

UNEP’s definition of a green economy is “one that improves human well-being and social equity, while

significantly reducing environmental risks and ecological scarcities”. In order to move towards a green

economy, the private sector, especially the insurance industry, will need to contribute to the cause.

Because a green economy is good for business!

Global Environmental Issues:

Green funds can be invested into a number of vital areas for environmental sustainability, including

alternative energy, controlling pollution from industries, and mitigating carbon footprints from various

sectors. In addition, some of the major concerns over the last few decades have been the decline of

primary forests, particularly those from tropical regions. While natural regeneration of forests and

re/afforestation measures in many parts of the world have helped to compensate for these losses,

concern over growing food demand in the future puts more forests at risk. More importantly, it is

estimated that emissions from deforestation and forest degradation are higher than the transportation

2 http://www.naturalcapitaldeclaration.org/2012/06/37-finance-ceos-announce-commitment-on-

natural-capital-at-rio20/

3 http://www.unepfi.org/psi/wp-content/uploads/2012/05/United-Nations-press-release-The-UNEP-FI-

Principles-for-Sustainable-Insurance_English.pdf

4 http://www.unepfi.org/psi/wp-content/uploads/2012/05/United-Nations-press-release-The-UNEP-FI-

Principles-for-Sustainable-Insurance_English.pdf

sector – accounting for 20-25% of greenhouse gases5. Given these findings, our focus is turned to

forests and the ecosystem services they provide globally.

Global warming is largely attributed to the disturbance of biogeochemical composition of the

atmosphere, namely from increased influxes of carbon and nitrogen gases (see Figure 2 below). One of

the main responses to global warming is to reduce atmospheric carbon from land use changes (Feddema

et al. 2005). Tropical forests play a globally important role in sequestering carbon (a major greenhouse

gas) in their biomass, thus helping to mitigate global warming by acting as ‘carbon sinks’. They provide

this important ecosystem service (ES) along with many others, such as watershed protection and

recreation, which society at large has enjoyed freely. However, we are losing these services at

unprecedented rates. Forests around the world are being cleared for agricultural and other land uses

thus becoming a ‘source’ of carbon and nitrogen gases (or GHGs – see Figure 3 below).

Figure 2: Graph showing influx of major greenhouse gases from 1978 to 2010. Source: National Oceans

and Atmospheric Administration (NOAA) – US Dept of Commerce6

5 Myers, E. C. (Dec 2007). "Policies to Reduce Emissions from Deforestation and Degradation (REDD) in

Tropical Forests". Resources Magazine: 7. Retrieved 03 July, 2012.

6 http://www.esrl.noaa.gov/gmd/aggi/

Figure 3: Greenhouse gases (GHGs) from land-use impacts on carbon and nitrogen (C/N) flows

(Sarkissian, A. [2012])

Defining ecosystem services and their importance Ecosystem services are the elements that nature gives us for free, which we take for granted, such as

pollination of trees, clean water, clean breathable air, etc… all the basic things that are freely given by

the earth and which are slowly being abused and destroyed directly or indirectly by human’s actions and

decisions.

Ecosystem services (ES) are defined officially as “the benefits that people obtain from nature” (MA

2005). They are “the conditions and processes through which natural ecological systems, and the

species that make them up, sustain and fulfill human life” (Daily 1997). The Millennium Ecosystem

Assessment – MA (2005: v) provides a framework which classifies ES under four main categories:

1) Provisioning services (e.g. food, water, timber and fiber),

2) Regulating services (e.g. climate, floods, diseases, wastes, and water quality),

3) Cultural services (e.g. recreational, aesthetic, and spiritual benefits), and

4) Supporting services (e.g. soil formation, photosynthesis, and nutrient cycling).

Land Abandonment or Retirement

Natural Regeneration & Protection

Reforestation & Forest

Restoration

Traditional Agriculture &

SFM (low-impact)

Deforestation & Commercial

Agriculture (high-impact)

C/N

Sink

C/N

Sou

rce

Low

(terrestrial)

High

(atmospheric)

Neutral

Figure 4: Description of the services and dis-services to and from agriculture, Zhang et al 2007, p. 254

Other important services from ecosystems, particularly forests, include mitigating erosion from wind

and rain. Ecosystem services are elemental in the formation and maintenance of soils and the nutrients,

as well as providing important pollination services from birds, bees and other insects. While dryland

forests, such as those found in the MENA region, provide relatively little services in absorbing carbon

within their plant tissue (e.g. biomass) than that of tropical or temperate forests, the natural vegetation

in these landscapes maintain carbon and nitrogen cycles in balance within the soil.

When land is converted for commercial agriculture and the natural vegetation is removed or burned,

carbon and other GHGs, such as nitrous oxide and methane from agrichemicals, are emitted into the

atmosphere, (Vitousek et al. 1997). Hence, farming methods can either enhance or degrade these

ecosystem services, which is largely dependent on what incentives farmers or landowners have on the

table (Tilman 1999). The diagram above (Figure 4) illustrates some of the services and ‘dis-services’ from

agri-ecosystems (Zhang et al. 2007).

Example: Native species protecting crops against ecological change? Native species are adapted to the local ecology and help to balance soils through their associations with

other life forms, including birds, insects, microbes and fungi. Soils are created over time from litter and

dead matter from these life forms. Conventional agriculture often reduces this capacity and thus limits

the ability of ecosystems to maintain stable and resilient states. These are important functions that

native species play in ecosystems and ensure broader services, including the natural resources needed

for producing food, e.g. pollination.

A more holistic view of ecosystems is to recognize that they are essentially coupled with social systems

(Berkes and Folke 2000). Natural and social systems have evolved over millennia through a symbiotic

relationship, and humans have developed special skills and technology to utilize natural resources more

efficiency, thus increasing our chances for survival in addition to increasing our population. Yet we have

reached a ‘tipping point’ where collective action is needed to prevent us from going beyond the

resilience threshold.

Hence, sustainable resource use is largely determined by how well resilience is maintained in complex

social-ecological systems. Resilience is defined as the capacity of an ecosystem to absorb a perturbation

and still return to the pre-condition state, while maintaining its essential characteristics of species

composition, structures, ecosystems functions, and process rates (Holling 1973, Folke et al. 2004). Figure

5 below is a simple illustration of resilience framework.

Figure 7: Panarchy – Resilience Ecology (Gunderson and Holling 2002)

Payments for Ecosystem Services: How can we pay for something that is Free? As a landowner, I buy the right to do whatever I want with

my land, provided it does not contradict with the law. Today, our Mena region has very little regulations

in place to preserve a healthy “earth” Given this, how can we drive people, and landowners specifically,

into conserving viable ecosystem services to service society?

To get into the official definitions, payments for ecosystems services (PES) is described as the inverse of

the ‘polluter pays’ principle to control negative externalities to the ‘supplier gets paid’ for providing

positive externalities, or external benefit (Engel et al. 2008). The theoretical foundations for a PES are

defined by Wunder (2005) as:

1. a voluntary transaction where

2. a well-defined environmental service (or a land use likely to secure that service)

3. is being ‘bought’ by a (minimum one) service buyer

4. from a (minimum one) service provider

5. if, and only if, the service provider secures service provision (conditionality).

Figure 5: Simplified flow-chart depicting ecosystem service payments. Courtesy of FAO7

From a principal-agent framework, the service ‘buyer’ (in this case the fund) can be considered as the

contracting ‘principal’ and the service ‘seller’ (in this case the landowner) as the contracted ‘agent’. In

such contractual arrangements, a conditional agreement is reached between both parties with the

solicited expectation of increasing or enhancing a clearly defined environmental service (ES). This

includes alternative land-use practices, where payments may be based on estimating the opportunity

costs foregone to land conversion, e.g. avoided deforestation (Wunder 2007).

7 http://www.fao.org/es/esa/pesal/aboutPES5.html

Applying Payments for Ecosystem Services:

Since agriculture is a risky venture for most small famers, having the option to produce other ecosystem

services besides food production can enable for both improved livelihoods and environmental

protection. In other words, farmers can make just as much if not more money from producing less

commodity products if they provision other ecosystem services, such as planting and managing some of

their land with forest trees.

Since many of these measures are relatively costly, it is therefore important to prioritize areas that are

more vulnerable to degradation, or less resilient, which could then affect other ecosystems in the long

run. Adverse selection from incomplete or asymmetrical information is one of the main problems

insurance companies face. Similarly, these dilemmas can affect green fund investments, which can also

include payments for ecosystem services schemes (Ferraro 2008, Zabel and Roe 2009).

Abandoned agricultural lands can potentially return to their original states ‘natural’ states. Some,

however, are in need of interventions at various degrees and inputs. This includes passive restoration,

also referred to as assisted regeneration, which involves mainly protection and maintenance. Those that

are showing signs of degradation, or are located on poor soils and south-facing aspects (high heat in the

summer) would benefit from active restoration, e.g. native tree/shrub planting, to prevent further

erosion and enhance landscape beauty.

Active and passive restoration measures are key strategies that not only help combat global warming

and desertification, but can also help local communities find alternative incomes for protecting their

land from soil erosion. While the Arab and Mediterranean region are seeing declines in the agricultural

sector, opportunities for making good (or even better) use of the land are available through a proposed

green fund through conceptual PES schemes.

Moreover, PES acts as a tool for sustainable food production and food security. In essence, achieving

food security requires not only the production of food, but also maintaining vital ecosystems services

needed for producing food in the future. Knowing the extent of land-use changes and its impacts on

ecosystems will allow for farmers and land managers to make better decisions on what to grow and how

much.

Other financial instruments protecting forests Reduced Emissions from Deforestation and Degradation, or REDD, emerged following the Kyoto

Protocol8 as a financial, market-based instrument for protecting forests in an effort to reduce

greenhouse gases from deforestation. REDD/REDD+ schemes are intended to offset carbon emissions,

i.e. carbon credits, through trading in carbon markets. But there have been concerns raised as to how

8 A protocol of the UN Framework Convention on Climate Change (UNFCCC)

effective these markets will be in reducing emissions, while criticized for not delivering co-benefits, such

as biodiversity, development and human (e.g. indigenous) rights9.

Figure 6: Project land-use changes and biodiversity loss (GLOBIO3), (Nellemann and Corcoran 2010)

9 Vatn, A. and P. Vedeld (April 2011). "Getting Ready! A Study of National Governance Structures for REDD+". NORAGRIC.

Retrieved 03 July, 2012.

Why Pay if it’s FREE? The above is one of the main arguments used by neoclassical economists with regards to environmental

degradation points to externalities, or the social costs and benefits that are accrued or unaccounted for

by society, respectively. In other words, deforestation and the conversion of land to more productive

systems, e.g. commercial agriculture, result because the goods and services from forest ecosystems are

absent from markets, or in other words, they are externalities. Producing apples has more benefits to a

landowner in relation to the costs of having more native forests because apples are bought and sold in

markets. On the other hand, ecosystems services from native forests, e.g. watersheds protection and

erosion control, are not. Having ‘escaped’ the market, such ecosystem services will be considered

externalities until individuals, groups or governments start paying for them.

Figure 8: Diagram showing how positive feedback effect of unsustainable development, Barbier 2011, p.

237

The root of the problem according to many environmental economists is the lack of institutional

arrangements, whether public or private, to incorporate natural capital into the valuation of products

and services derived from nature. Barbier (2011) illustrates this in the diagram above. Given the lack of

proper valuation process for environmental goods and services, there is no analysis to signal ecological

scarcity in order to develop policies and solutions through the 5 “I’s”; information, incentives,

institutions, investments and infrastructure (Barbier 2011). Without these policies,

ecosystem/environmental services will continue to be treated as public goods, or externalities, and we

will continue to lose them in the future.

Regional Environmental Issues (MENA)

Coping with Global Warming One of the major threats posed by climate change and global warming in the MENA region is

desertification (see Figure 9), or the gradual transformation of fertile land into desert resulting from

drought, deforestation, or inappropriate agricultural practices10. While agriculture activities are

declining in some parts of the region due to globalization (e.g. subsidized produce and foodstuffs are

cheaper to import), increasing global demands are expected to stimulate the sector in the near future.

Yet if improper agricultural activities geared towards commercial food production continue,

accompanied by more deforestation and/or land conversion, the natural resources generated from

already vulnerable ecosystems will continue to diminish.

Figure 9: Desertification index for MENA countries

10 Princeton University "desertification" WordNet. Princeton University. 2010.

http://wordnet.princeton.edu, accessed 02 July, 2012 – 15:00 GMT +2

While there are no straightforward solutions to this global dilemma, there is no reason to ignore the fact

that sustainable food production is possible. Locally produced and consumed products will stimulate the

GDP of a given nation and reduce costs and emissions related to transportation (import/export). Saudi

Arabia, which was largely dependent on imported foodstuffs, is investing billions of dollars towards

boosting the Kingdom’s agribusiness market11. While this may be boost its GDP and increase local

revenues, export markets from neighboring countries are likely to be affected. What does this mean to

farmers who are heavily dependent on this market?

Role of Insurance Landowners, especially farmers, generally face high risks in deciding what to produce because of their

lack of information in markets, e.g. consumer demand. Landowners in more rural villages also bear the

added disadvantage of access to markets, especially in developing countries lacking public infrastructure

such as roads. Is it fair that they are left in the dark with limited choices of what to produce? Should

governments control production through tariffs or subsidies, or should landowners have the option to

produce other goods?

Much of this relies heavily on whether the private sector is willing to invest in ecosystem services as

‘buyers’. If there is a clearly defined ecosystem service that at least one principal (buyer) wants more of

and willing to negotiate a transaction with an agent (seller) who accepts the terms presented

voluntarily, ES can be produce just like any other commodity, only that they provide external benefits

instead of costs to the society at large.

As agricultural systems become more complex and efficient, wealthier countries such as the Gulf States

will be producing food hydroponically much cheaper than those produced traditionally. Farmers from

other MENA countries will not be able to compete (or adapt) with these markets. What will become of

declining agricultural sectors in the rest of the MENA?

An example of a microfinance PES scheme geared towards local, poor and marginal communities in the

region can be designed to compensate a farmer, coop (group of farmers) or landowner to plant fewer

crops and more native species. The more the farmer decides to retire, the less he has to pay back from

his microcredit loan. In essence, the agent(s) are making money from what they borrowed through

reverse interest. These deductions are covered by a green fund.

Moreover, agents who sign up to these schemes will be automatically covered with micro-insurance

inclusively. This would cover any potential losses faced much like any other agricultural insurance

product. The only difference is that the losses, if any, would be much less than that of large-scale

commercial agriculture. Other potential losses would be compensation for selling organically grown

produce that cannot compete with its conventionally grown rivals.

The agent, in return, would be indirectly restoring his or her lands through assisted regeneration (or

passive restoration), at the lower end, to active restoration, such as marginal lands that are sloped or

11 http://www.zawya.com/story/Saudi_agribusiness_valued_at_22b-ZAWYA20120625041723/

prone to erosion and degradation. If in fact the agent produces more ES, the external benefits are

enjoyed by the neighboring plots of land, which could potentially facilitate further negotiations and

transactions.

If enough landowners with substantial tracts of farmland are voluntarily willing to accept payments for

producing what they may believe are worthless native trees, the PES buyer would be credited with

increasing biodiversity through connectivity corridors. This would result in a rather stark contrast to that

of the common landscape, where abrupt and sporadic land-use changes isolate natural ecosystems. This

is generally true in many instances where nature reserves are gradually eaten away at the margins

namely due to command-and-control resource regimes from central governments.

Micro-financing Schemes:

While some studies have highlighted the importance of providing micro-finance packages, which include

micro-credit and micro-insurance, to poorer communities to help bolster food production and food

security, these schemes tend to overlook the long-term sustainability of the environment (e.g. Zeller and

Sharma 2000). Given the increasing impact that commercial agricultural activities have on ecosystems

and the environment, e.g. agrochemical runoff, loss of biodiversity, risk adverse to climate change, etc.,

more incentives are needed to bolster more conservation measures towards food production.

Conservation agriculture and agroforestry practices can enable communities to secure food during

periods of scarcity, e.g. during droughts or other extreme incidences, while managing ecosystems for

greater social benefits from diverse services.

The question that emerges from a development perspective is how will these communities make a living

from such low-income generating activities, even though they are preserving the environment and

meeting their basic needs? Families within these societies want their children to get educated in order

to find better jobs. They want to be able to afford medical care as well as raising their standard of living.

How can they do this under such schemes?

This is where the PES scheme becomes an added value for individual households and communities that

become environmental agents. Because they are producing a social benefit, something that has

generally been an externality especially under current political and economic systems lacking

institutional mechanisms, green funds can pay the opportunity costs of the farmer’s who opt out of

more commercial agriculture. Hence, by planting more native trees near watersheds and areas prone to

erosion and flooding, and by using fewer inputs that are themselves costly, e.g. fertilizers and pesticides,

farmers will be compensated for provisioning ecosystem services and conserving biodiversity through

the green fund.

The cost to the PES buyer in relation the environmental benefits

The main costs that will need to be factored in to the PES buyer (i.e. Green Fund investors), aside from

the initial payments to the PES provider (or seller), are transaction costs associated with contracting

(e.g. determining which ES will be increasing) and monitoring (e.g. annual or biannual biophysical

surveying of the fields). Issues with bundling services, such as carbon and biodiversity, would also

produce another set of challenges and additional costs. Perhaps the best method is to design various

contracting schemes that deal with individual services at first, which can then be amended with co-

benefit contracts in the future.

Other things that we can gain from this fund include but is not limited to the following:

Social learning – evaluating the values of biodiversity and ecosystem services

Social learning is an important aspect that enhances both researchers and local communities where

research is being conducted. From the social learning process, land managers and researchers are co-

managing social-ecological systems through more adaptive measures, thus reducing the risks and overall

costs, while enjoying the benefits together.

We can take for example landowners who may choose to plant only pine trees on their land, regardless

of whether or not the soil type is fit for the trees. If they were to invest in planting other native species,

some of which can help nourish the soils, such as nitrogen-fixing species, they can help improve survival

rates as well as health and vigor of other forest (or fruit) trees.

The drawback (or marginal costs) beyond that of additional investments is that they are no longer

planting for commodity production, e.g. homogenous orchards or plantations, which requires more

input but higher returns. The advantage is that they are increasing biodiversity and resilient ecosystems,

which acts as an insurance against further land degradation, erosion, desertification and, potentially,

climate change.

Eco-branding and corporate social (environmental) responsibility – raising the stakes in a

competitive market:

Firms, much like ecosystems, must adapt to change in order to survive and maintain resilience. Learning

is a fundamental tool for achieving this as the ‘panarchy’ diagram illustrates (Figure 5 above). Resilience

is accomplished through adaptive co-management using cooperative measures in a competitive world

with scarce resources. But firms and other social systems, unlike natural systems, need people to

survive. As people become more educated and better informed, they will begin to make more rational

decisions pertaining to both public and private life. Having to choose from many competitors will

become easier because we are evolving and adapting measures towards a green economy.

Hence, if firms have the capacity to incentivize farmers to produce food more sustainability, they should

also be capable of incentivizing the same farmers to produce other ecosystems services as well. Value-

added commodities, whether products or services, are what people will be geared towards because

even consumers feel they have a responsibility to play. Branding of goods and services that are good for

the environment, in addition to contributing towards more socially respectful business ethics, will

increase revenues dramatically.

Conclusion Green funds are instrumental for stimulating a green economy. Attitudes and behaviours towards the

environment need to change, and we don’t have much time to witness slow transitions. One of the most

effective ways to meet this challenge is through voluntary markets, where buyers (e.g., firms) and sellers

(e.g. farmers and land mangers) can engage in transactions freely and openly. In many societies, these

transactions may not even involve money or the trading of goods, but rather information and

knowledge that form the basis of providing services. It is time to integrate ecosystems services into our

economic transactions and begin treating them like scarce resources in an era of uncertainty.

Social institutions will change to meet societal needs. It’s time to uncover the spectrum of probabilities

we face in the near future and deal with them directly. While many critics will dismiss PES as another

failed attempt to find a silver bullet to our environmental problems, we should always be reminded that

complex problems need complex, and generally a diversity, of solution options. PES is one of the

numerous options and designs should be carefully crafted to meet the baseline criteria while ensuring

that terms will carry over for longer timeframes (some would suggest 2-3 decades).

In summary, PES would guarantee incentives for farmers who follow institutional arrangements

(contract terms) negotiated between the parties. Whether or not the terms would change in the future

will depend on how developed national institutions in maintain order and deterring cheating. While it

may be difficult to punish a PES supplier for breaking or violating a contract agreement, there are fewer

chances that agents would risk losing guaranteed payments for doing less work than facing less

desirable consequences for putting excessive time and money into producing crops that would generate

fewer returns.

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