Optimal investment paths for environmental market assurance programs at the industry level.

Summary

MLA faced an increasing number of cases where it needed to prevent or minimise large potential losses caused by events outside its control. These losses often originated from government regulation, consumer action, media pressure and special interest groups that have increased their mass influence through globalisation and the explosion of alternative media on the internet. Examples include the Animal Welfare issues that disrupted live cattle exports to Indonesia, and the increasing attention that consumers and markets paid to environmental issues in their choice of suppliers. Given that these trends were likely continue into the foreseeable future, it was strategically important for MLA to develop analytical capability that would allow it to plan for the long term, and also to react to unexpected events quickly and minimise or avert potential losses.
In the case of insurance investments that are the focus of this report, it was necessary to have good information about the markets at risk, and some idea of the likelihood that these markets would be lost in response to uncertain events, such as the closure of trade caused by concerns over Animal Welfare or environmental impact. It was also necessary to have good information about alternative markets where the displaced product could be diverted, because supply effects may cause prices to drop and this needed to be considered in the analysis. In some cases alternative markets may not exist and other losses were calculated, such as the costs of feeding cattle that could not be exported to Indonesia recently.
This report addressed the issue of insurance investment to prevent losses in the context of the risk that mandatory environmental certification will be introduced in key markets.  Three evaluation methods were analysed in increasing order of complexity: static discounted cash flow analysisdecision tree analysisand real options analysis. The information requirements to implement these methods were examined and the key recommendations are that the types of decisions that can be made as uncertainty unfolds through time must be clearly defined, and that the decisions available at any point in time must be expressed as functions of decisions taken previously (i.e. path dependency is important). For example, the loss from introduction of mandatory environmental certification in a market will be smaller when quick action is possible, because of past investments in environmental assurance, than when past investments have not occurred.