Environmental Performance Bonds - Insurance Contracts

Environmental protection cannot rely on charity funding alone. We work on developing novel finance and incentive mechanisms for environmental and biodiversity conservation.

A fundamental gap exists between the existence and extractive value placed on ecosystem and biodiversity services. That gap often leads to incentives to overexploit those services. Second generation financial instruments could help narrow that gap and incentivize environmental stewardship. In nations with strong property rights and contract laws, a performance bond-insurance approach could streamline environmental compliance processes, incentivize stewardship, and proactively keep species from reaching endangered status.

Recent development in renewable energy projects in the southwest United States provides a potential example. At the moment, dozens of solar-power companies are petitioning the U.S. Government for permission to build power plants on publicly owned land that is also home to federally listed endangered species. The government or a third-party could issue (and require) an insurance-performance bond contract based on the health of the endangered species to the entire solar sector in the southwest. Such a contract would do the following:

◆ Provide annual assurances to the government (and/or a third-party) that if the solar sector does not perform environmentally, funds would immediately be available for endangered species mitigation;
◆ Provide a mechanism to allow for timely permitting and environmental compliance for the solar sector (a recent financial analysis by Ardour Capital Investments suggests that environmental compliance is the main risk with respect to solar development in the US); and
◆ Provide incentives to the solar sector for environmental stewardship.

In sum, an annual insurance-performance bond approach would cost-effectively align the incentives of all parties, as well as spread the risk of environmental compliance. For the government (and/or third-party), the contract acts as an insurance policy (which would be cheaper than litigation), while for the solar sector, the contract is an investment in environmental performance (e.g., the health of endangered species) in exchange for timely permitting. If the solar sector performs environmentally, they are rewarded. If they underperform, they are penalized financially. By structuring the contract with the entire sector (i.e., multiple solar companies), the risk is spread across multiple parties, while also incentivizing sector-wide environmental stewardship. The details of the contract could and would differ depending on the situation and interests of the parties (see simplified schematic for one potential structure).

For more information, see

◆ ACS’s article in SEED Magazine, Why Environmentalism Needs High Finance.

◆ A detailed, concept paper in the scientific journal Frontiers in Ecology and the Environment.

Partners: Cornell University, USA; Evergreen Conservation Finance, USA.