Changing claimant behaviour the retro way

Is it possible to decarbonise claimant behaviour in the US? The retro market thinks it is. Tom Johansmeyer, head of PCS, explains how…

Last month Ariel Re successfully sponsored Titania Re III. Just another cat bond? Not quite: this one incorporates an innovative carbon offset feature, using methodology developed by PCS, as Johansmeyer explains to Emerging Risks:

“The beauty of it is that it functions like an ILW. It occurred to me that if you can do claims settlements that trigger on a PCS number-  if they hit a certain threshold, which is what an ILW is –  then why can’t you do other stuff that triggers on a PCS number? Simultaneously, there are carbon derivatives out there, so why couldn’t you do one in this context? So this is a derivative that functions like an ILW. But this has a carbon offset consequence rather than a claim payment consequence, which settles at a purchase of $60k worth of carbon offsets.”

“We did this as a proof of concept with Titania, and we all looked at this as an innovative first step which is there for subsequent transactions to build upon. Pick a strike price- $100 billion or whatever you decide, and what we did was say that the notional in the cat bond is  of that transaction, and we took a market share that the cat bond covers for the underlying loss that triggers it: that’s how much of the carbon consequence of the cat the ILW will have to offset. We figured that in this case, you have to buy a certain amount of carbon offsets if it breaches that trigger in price, and we pre-agreed a rate for those carbon offsets. We set that rate high enough that it’s almost impossible to be accused of greenwashing, unless you object to the carbon offset concept in general.”

Decarbonising the trade

“What you’re doing is you are paying a premium up front, which is based on the expected loss, to reserve a certain number of carbon offsets, at a pre-agreed price that, if the instrument triggers, the sponsor then has to go and buy those carbon offsets to decarbonise the trade. We calculated a narrow view of this, admittedly, as it was a proof a of concept, but we decided to stick to our knitting at PCS. We know industry loss.”

“Let’s take auto. We reached out to some of data contributors in the US insurance market, and asked for a cat of size ‘, how many of those cars are totalled? And that’s important, because we wanted to look at the delta between legacy vehicles and plug-in hybrids. So a legacy pumps out a little bit more than 5.9 metric tonnes of carbon a year in the US, based on an average mileage of 14,500 per driver. A plug-in hybrid takes that number down by 2.45 metric tonnes.”

Offset calculation

“The problem is, you have to look at totalled losses because if you have a smashed windscreen from hail, you’re not scrapping the car. It’s a blunt instrument, admittedly, but it gets the job done for the first trade. So we calculated the amount of carbon offset that could be prevented by replacing totalled vehicles with plug-in hybrids. We did contemplate the rate of EV and hybrid penetration, but it was so small that it didn’t matter!”

“What this meant was that we were able to calculate, from an cat event, what the potential carbon savings from upgrade to plug-in hybrid would be. Now, this is America, so you know that no-one is going to replace their cars with hybrids, so we figured this is what we have to offset. And we went through similar calculations with personal and auto as well. 

What we’re solving for here is claimant decision-making that fails to advance an ESG agenda. My dream is that someday, this method becomes irrelevant because people purchase EVs or something similar, but for now we’re saying that as a retro transaction, we’re going to do our part to decarbonise claimant behaviour.”