PCS worked with Ariel Re and the structurer, Howden Tiger Capital Markets & Advisory, of the reinsurer’s Titania Re catastrophe bond issuance to create the innovative carbon offset feature, discusses Tom Johansmeyer, Head of PCS, a Verisk business.
Titania Re (Series 2023-1) is the third cat bond to be sponsored by Bermuda-based reinsurer Ariel Re, but the first to include a carbon offset feature, designed to offset some of the carbon from housing rebuild and replacement post a qualifying catastrophe.
Once the deal was finalised, the company’s management hailed the first-of-its-kind carbon offset feature, explaining how the reinsurer took the initiative to help build back greener after a natural disaster.
A carbon offset inclusion was something Johansmeyer of PCS had been developing for industry-loss triggered cat bonds and ILWs, but it’s by working with both Ariel Re and the structurers of Titania Re (Series 2023-1) that enabled PCS to create a solution that works.
In light of this, we spoke with Johansmeyer about why this inaugural carbon offset cat bond transaction matters, why it came about in the first place, and just how widespread the use of a carbon offset in ILS transactions could become.
In terms of the overall why, Johansmeyer explained that the re/insurance and ILS community has struggled to develop new and innovative ways to address ESG considerations, notably at a time when end investors are becoming more and more interest and insistent on the matter.
“It’s tough for the industry, especially through reinsurance and retro. It takes too long to get a sense of what’s being covered in the treaty, and you might not even know until after you’re on the deal. And for industry loss index instruments – either ILWs or cat bonds – the index is the index, and that includes losses to fossil fuel companies and others that may be considered environmentally unfriendly (e.g., hotels and airlines) where the relevant insurance policies respond to a catastrophe event,” said Johansmeyer.
“So, at first blush, it looks like there isn’t much the re/insurance industry can do to develop a cat-focused ESG-friendly product. For years, I’ve heard cat reinsurers and ILS funds claim that they are ESG-friendly because they write cat business, relying on the implied connection between catastrophe activity and climate change, but that was never broadly accepted by end capital. And the notion that reinsurers are modelling to better reflect climate change may mean a move toward more appropriate rates relative to the risk, but from an ESG perspective, it’s nothing more than increasing the price of the end of the world,” he continued.
In response, PCS developed an approach to decarbonizing ILWs and industry loss index cat bonds that Johansmeyer says is straightforward, easy, and effective.
“Our initial effort has been to focus on claimant decision making, and that’s what was implemented in Titania Re. PCS developed tools to determine the addressable carbon reduction through post-cat remediation. For example, that includes the delta in carbon emissions between legacy vehicles and plug-in hybrids, scaled across the vehicles totalled by a major catastrophe event.
“We developed that thinking through all classes of business covered by a PCS estimate and linked it to cat size (in industry loss) and a transaction’s share of the industry loss. This gave us the inputs necessary to develop a PCS trigger threshold for a carbon offset ILW,” said Johansmeyer.
So, given a PCS estimate of a certain size, the sponsor of the transaction would purchase a pre-agreed number of carbon offsets at a pre-determined price.
“Really, it’s a simple ILW pointed at carbon offsets. It’s simple, and it works. With time, I hope to see this initial proof of concept grow into something more sophisticated and dynamic,” continued Johansmeyer.
But what does the inclusion of carbon offsets in ILS transactions mean for both cedants and investors?
For the former, Johansmeyer believes that decarbonizing risk transfer could help increase access to capacity, and bring new capital into the market, while simultaneously help cedants make tangible, measurable progress toward ESG objectives.
“It may not do much deal by deal, but the medium- and long-term benefits should be to engage a broader base of end capital providers which should help an industry that is currently capital constrained,” he explained.
“Additionally, it provides at least one answer to the ongoing ESG questions that they get from shareholders and other stakeholders. The process used for Titania Re, because it’s aligned with PCS estimates, is straightforward and recognizable. If you’ve seen an ILW, it’s pretty easy to wrap your head around the carbon offset feature.”
When it comes to ILS fund managers, who Johansmeyer revealed have been coming to PCS for several years with questions about how they can develop ESG-friendly solutions, they should care about decarbonizing risk transfer because their end investors do.
“It took two years to come up with a workable idea (the carbon offset feature in Titania Re) and then another two years to get the first implementation complete. We’ve had plenty of interest, but none were able to get over the goal line. Using carbon offsets to add an ESG component to ILS results in an alternative that is transparent, efficient, easy to quantify, and in alignment with existing ILS instruments,” he said.
The Titania Re (Series 2023-1) transaction was well-received by ILS investors, and Johansmeyer hopes that it is the first of many.
“I’d love to see this approach become pervasive and improve with the collective efforts of our industry as a whole. With a process in place and a proof of concept completed, I’d love to see some of the mid-year ILW trades use the carbon offset feature, and we’re always happy to build it into more cat bonds,” said Johansmeyer.
He went on to explain that alongside the U.S., PCS has already done the legwork for both Canada and Japan, and that Mexico would also be fairly easy to get done.
“From there, the effort is more about data inputs and quirks of the risk areas than the methodology. We’ve spoken with clients about decarbonizing European index transactions, for example, and we could have something up and running in relatively short order.
“What’s really interesting, though, is the potential uses outside industry loss index. It’s possible to set an industry loss benchmark for a UNL transaction or even an entire book of business (or company) and then use carbon offset transactions strictly for decarbonization of a portfolio without lining it up to a specific ILW or cat bond transaction.
“That’s what could take the impact of the carbon offset ILW concept from $5 billion to $500 billion… although for now, I’d just be happy to see a few more trades come through!” said Johansmeyer.
You can read all about the recent Titania Re Ltd. (Series 2023-1) catastrophe bond issuance from Ariel Re, as well as details on over 900 other cat bond transactions in the extensive Artemis Deal Directory.
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