Leveraging collaborative models to de-risk and commercialise innovation

In 2022, natural catastrophes resulted in global economic losses of USD 275 billion. This continues a trend (based on 10-year moving averages) of 5-7% annual growth, largely attributable to the increasing frequency and severity of extreme weather events and climate change.

As well as advancing efforts in terms of climate mitigation, there needs to be investment in climate change adaptation and creation of more resilient infrastructure, communities, and economies. This means society needs to think more innovatively, explore and invest in sustainable approaches, incorporate more green components and nature-based solutions into infrastructure planning, and improve access to services for vulnerable communities.

There are many great ideas to help mitigate and adapt to climate change, but these ideas are only as good as their execution. Unfortunately, many will remain in concept or R&D phase because they lack sound commercial business models. Or they remain focused on the research and don't progress into the testing or pilot phase to deliver early results.

This is where the private sector can help – not just with financing, but with execution experience, strong governance, and de-risking. The private sector has the strength and power to drive long-term positive change. For example, the Alliance of CEO Climate Leaders is a group of 124 corporates operating in 12 industries across 27 countries, and generating more than $3.5 trillion in revenue. This network represents business leaders who are committed to using their position and influence to support the transition to a net-zero economy.

Catalytic funding can help redirect existing finance and scale up nascent ideas to commercial levels. Blended finance is one mechanism that can support sustainable development, by combining catalytic, public, and private capital. However, to successfully scale, the sequence and allocation of funding in blended, or multi-stakeholder arrangements, is critical:

1. Catalytic funding in the form of grants, government incentives or 'impact investment', enables the development of innovation, pilots, and proof of concepts. This also absorbs the initial risk, or first loss.
2. Private sector funding instils the appropriate governance and assurance to shift the mindset from experimentation to commercial deployment. Ideally, the blended model becomes obsolete as full commercial operations are achieved. 

Change comes with risks, as established practices are adjusted and new business models developed. Collaborative models spread the costs and risks of change over several different actors. As investors' motivations and expectations of returns vary, blended finance models that recognise positive externalities can help launch projects that would otherwise be challenging to get off the ground. For example, investors managing money for third parties have fiduciary responsibilities to maximise risk-adjusted returns and may be more conservative in their investments. However, when the initial risk (or first loss) is taken by philanthropic grants or government incentives, it reduces the exposure for private investors and allows an initial pilot to proceed and demonstrate proof of concept.

It is also important that blended finance is right-sized and truly used as a catalysing and transitionary approach – so that reliance on philanthropic funds does not extend longer than necessary and crowd out commercial capital. The goal is for initiatives to scale and become commercially self-sustaining, rather than remain dependent on concessional funding. 

Multi-stakeholder arrangements can allocate risk to the parties best placed to manage it, which includes the transfer of risk to insurers where feasible. Furthermore, insurance helps improve the certainty of returns.

Traditional indemnity-based insurance provides a payout after losses have been incurred from a significant weather event, natural catastrophe, or other shock. This ensures a project can be restarted or continued, or compensation provided. Index-based or parametric insurance is a pre-agreed contract to pay out a defined amount in a specified circumstance. Claims are triggered automatically by reliable and objective indices – such as weather, satellite, and remote sensing data – so the payout is received faster than under traditional indemnity conditions. This type of insurance best supports the provision of funds for emergency response, early intervention, and rapid recovery activities. Whether indemnity or index-based, knowledge that insurance coverage is in place at the planning and design phase provides peace of mind to lenders and investors.

As insurance companies are focused on managing risk, they have valuable insights and experiences to share. For example, Swiss Re's proprietary CatNet® portal is used by more than 15,000 insurance professionals globally, as well as by governments and universities, to better understand natural hazards, flood risk and potential vulnerability of biodiversity and ecosystem services.

For public sector actors, having an insurance program in place facilitates fast action to be taken in managing the impacts of disasters and shocks on communities. This was the case for the state of Quintana Roo in Mexico, when they first took out an insurance policy to protect their coral reef against hurricane impacts. First launched by Swiss Re in 2017, the insurance payout was designed to be triggered by wind speed and cover the cost of the 'Reef Brigades', the team who go out after the storm in the boats, dive down and collect broken coral and replant fragments. This solution supports economic stability, as the area is highly dependent on the tourism income from the reef and ensures that funds are available to help maintain this important natural asset. In addition, the setup, training and subsequent expansion of the Reef Brigades was funded by the Swiss Re Foundation, demonstrating the combination of private, public and philanthropic collaboration.

In India, the northeastern state of Nagaland made the decision in 2020 to support disaster risk financing through insurance protection. Swiss Re worked with the local insurer and the Nagaland State Disaster Management Authority (NSDMA), and the transaction enabled the state to build fiscal resilience against natural disasters, particularly against the heavy monsoons experienced regularly in the region. In 2021, the program received a grant from the InsuResilience Fund to explore expansion into earthquake coverage. This example shows the important role of philanthropic and private sector actors to catalyse and support government risk management programs.  

For the local municipality of Texel Island in the Netherlands, private sector expertise and assurance resulted in an innovative dyke restoration approach on a world heritage site. The contracted dredging company proposed to reinforce the existing concrete dyke with a nature-based solution involving five million cubic metres of sand and the planting of two million marram grasses. Swiss Re provided the contract works insurance cover, providing the necessary assurances to deliver this new and unique approach. The project resulted in an island that is bigger, more beautiful, and more resilient against erosion risk, with the added benefits of enhanced fish production, climate regulation, and improved water quality.

Whether part of a blended model, public sector program or private investment, insurance is an effective mechanism to help manage risk and enable innovation and adaptation – all of which we need to see more of to manage our current climate trajectory.

To appeal to insurers, lenders and traditional investors, early impact funding should set up the feasibility of the idea and demonstrate proof of concept with early testing and data. These efforts enable risks to be better identified and managed for scaling.  

Innovative adaptation approaches are needed to make our communities and economies more resilient. Whilst philanthropic efforts will help catalyse such actions, the redirection of significant financial flows will take a strong commercial business case. Hence collaboration and embracing of blended financing and de-risking models can contribute towards a more sustainable and effective outcome for all.