November 1, 2023
“Experts have forecast that the carbon markets could create a $1 trillion opportunity by 2050. It is estimated we need to remove 10 billion tonnes of carbon from the atmosphere each year, and the projects and industries needed to do this will require trillions of dollars of investment – and insurance. For the world to hit Net Zero, the carbon markets need to scale up to the size of the existing fossil fuel industry within the next couple of decades. It depends on who you speak to, but even the most cautious forecasters predict this could equate to an opportunity for insurers worth $10bn-50bn in gross premium by 2050.”
2. Insurers are innovating a variety of carbon coverages
“At its most simple, carbon removal coverage is a property & casualty play, including coverages you would expect to see for project financing, scaling-up, construction and operational add-ons such as marine cargo and supply chain logistics – the bread and butter of the insurance industry. However, there are more bespoke carbon coverages being developed. One of the things Kita looks at is the lifecycle of carbon credit – including what the types of carbon are and who the stakeholders might be – and that’s where product innovation gets more specific.
Emerging niche insurance products include protection against delivery risk and reversal or permanence risk once carbon credits have been issued. For example, if a credit was issued linked to a forestry project, there’s a chance that a wildfire could affect that project and caused carbon to be released, creating a reversal risk. There’s also parametric play in the carbon markets. For example, a parametric product could protect against wildfires, or use a heat or flood index to determine the potential for a project to issue carbon credits.
Insurance is also well positioned to analyse and price risks associated with carbon market buffers. These are a type of self-insurance mechanism paid into by project developers which protect buyers in the event of a reversal. Cash flow is often a problem for project developers, and while buffer pools are a good thing, we might argue they aren’t the most efficient use of the developers’ capital. Insurers may be able to free up some of that capital through an excess of loss type approach or by being close to the action and providing a risk-adjusted view.”
3. Political risk is a threat to projects and an opportunity for insurers
“Another key element to consider as we evolve carbon removal insurance is the political risk associated with nature-based solutions. Most of these types of projects are in the global South – South America, Africa, Southeast Asia. At the moment, the rules set by the UN around how credits can be issued at a local level and then traded internationally are still being hammered out, so it isn’t fully clear on a per country basis what those governments may allow now and into the future. People are therefore looking closely at political risk.”
4. The shape of the carbon insurance market may change it matures
“Carbon risk is so new and evolving at such pace that in the short term it’s likely to remain a specialist play, as to build a good insurance product you really need to understand the risk. We have our own in-house political risk expertise but as an MGA we also partner with people with deep political risk expertise and we complement each other and learn from each other. As the carbon markets mature and scale up, it may make sense for political risk and other types of underwriters to develop dedicated carbon teams in the future.”
5. The carbon markets are becoming a safer bet
“The market is coalescing around standards and integrity and there is an absolute plethora of activity in this space, which means anything I say today will may be out of date in just a few months. The key focus areas are MRV – measurement, reporting and verification – and credit ratings. There are emerging carbon credit rating agencies taking a view on the likelihood of a project to issue credits and also the quality of those credits, and there is so much going on in the regulatory space on both the buy and sell sides of the market. We have, for example, the Core Carbon Principles being fine tuned by the Integrity Council for the Voluntary Carbon Markets (ICVCM) on the sell side, and the Carbon Claims Code of Practice being developed by the Voluntary Carbon Markets Integrity Initiative (VCMI). Then there’s guidance coming from the Science-Based Targets Initiative (SBTi) coming out in December and emerging regulations on carbon claims and disclosures on both sides of the Atlantic. This is all building towards clearer rules and disclosures and hopefully greater integrity, so the market is definitely moving in the right direction.”