Background to carbon markets
In recent years, many of the world’s largest companies have made commitments to reduce their net carbon dioxide emissions to zero. Carbon markets have developed to help companies meet their targets, but buyers, intermediaries and sellers of carbon credits face unique risks that are not suitably covered by conventional insurance products.
Companies looking to reduce their carbon footprint can fund initiatives to offset their emissions. Examples include planting or conserving forests, building renewable energy facilities and using carbon capture and storage (CCS) technology that directly removes carbon dioxide from the air.
The reduction in carbon emissions resulting from these projects can be represented by carbon credits. Each carbon credit is a tradable asset equivalent to one tonne of carbon dioxide removed from the atmosphere.
Some governments, such as the European Union, California and China, have created mandatory carbon credit trading systems, known as “compliance markets”. Certain companies, usually the highest emitters, are legally required to limit their emissions or purchase carbon credits to compensate. According to London Stock Exchange Group, the value of these compliance markets reached €881bn ($955bn) in 2023.
For most companies, which are not covered by these schemes, reaching net zero involves a combination of reducing their own emissions and purchasing carbon credits from the unregulated “voluntary market”. Of the companies monitored by Net Zero Tracker that have made commitments to net zero, more than a third specify carbon credit purchasing as a route to meeting their target. Most of the rest do not rule it out.
The size of the voluntary carbon market was just under $2bn in 2022. BCG estimates it will reach between $10bn and $40bn by 2030, while Barclays says a market size of $250bn is possible in 2030, then $1.5trn in 2050.
The carbon insurance opportunity
Insurance products specifically designed for the carbon markets are a recent innovation, so the current premium volume of carbon insurance is tiny in comparison to other product lines. By designing specialised carbon insurance products, the insurance industry has an opportunity to profit from this fast-growing market and provide the confidence and security that carbon markets need to grow further.
CFC’s head of innovation George Beattie told Sustainable Insurer: “I think [the carbon insurance market] has every chance of being as big or bigger than the cyber market. In the future, there’ll be two major risks: emerging tech and the planet we live on.”
In February 2024, MGA Kita and consultant Oxbow Partners estimated that annual gross written premiums for carbon insurance could reach $1bn in 2030, then between $10bn and $30bn in 2050. The divergence of carbon market growth predictions and the infancy of carbon insurance products today mean there is significant uncertainty around any premium predictions – but the opportunity to insure this rapidly growing market is difficult to dispute.
Insurance products available for carbon markets today fall into four categories: carbon credit delivery risk; carbon offset project risk; carbon credit invalidation and reversal risk; and unintended emissions risk.
Carbon credit delivery risk
Organisations often agree to purchase carbon credits before the reduction in carbon emissions has occurred, such as through forward contracts. This provides the upfront cash needed to support activities like tree planting, but it introduces the risk that the expected carbon credits never materialise.
The carbon offsetting project could be held back by natural hazards like fire or wind. The organisation managing it could go insolvent, abandon the project, be negligent or be found to have committed fraud. New research could reveal the chosen activity does not reduce carbon dioxide levels as much as previously thought. Governments could nationalise the carbon credit or block its export.
One type of insurance product covers this “delivery risk”. If a company pays for carbon credits to be delivered in the future, delivery risk insurance protects them in the event they do not receive the carbon credits they were promised. Carbon insurance start-up Kita launched a delivery risk insurance product in January 2023 and was followed by CFC in April this year.
“If we want more businesses to invest in tree-planting and carbon capture projects, we must help them make the investment without fearing risks beyond their control,” said Hayley Maynard, head of innovation at Chaucer, which is providing lead capacity to Kita.
Kita has agreed partnerships for its insurance to back carbon finance scheme Pyreg Climate Finance Solutions and Ecosystem Restoration Standard’s carbon buffer pool.
Differences in coverage between Kita and CFC include the length of the policy period. Carbon offsets require some time to take effect, depending on the method, so policy periods of more than 12 months are available. CFC is providing up to 18 months of coverage, and Kita up to 10 years.
CFC’s product includes cover for political risk, which Kita excludes, although Kita says it is looking to introduce coverage for political risk in the future.
Carbon offset project risk
Organisations that operate or finance carbon offsetting projects and sell the resulting carbon credits also face various risks. These include restoration costs if natural hazards cause physical damage, liabilities if they fail to deliver promised carbon credits, and lost revenue if they cannot sell as many carbon credits as expected. Certain events, such as a forest fire, could even cause a project to emit more carbon than it reduces.
As a result, some insurance products have been launched that are tailored to the risks of carbon offsetting projects.
Aon announced a partnership with carbon finance firm Revalue Nature in 2022 to insure nature-based carbon offsetting projects for physical and other risks. The initiative is intended to help attract investment to these projects by de-risking them.
Parametric specialists Descartes Underwriting and Arbol and start-up We2Sure underwrite parametric coverage for nature-based projects. Pre-agreed pay-outs are triggered by specific natural hazards such as wildfires or windstorms to cover lost revenue and other costs.
Some of these parametric policies could also be used as an alternative to delivery risk insurance for carbon credit buyers, covering only the natural peril risks that would cause non-delivery of carbon credits.
While those products only cover nature-based carbon offset projects, other types of projects also need coverage. For some, such as renewable energy facilities, there are established insurance products in the market.
However, for CCS projects, a fast-growing technology to reduce carbon emissions, the insurance industry is designing new forms of coverage. This is particularly aimed at CO2 leakage, the risk that some carbon dioxide is released by accident in the capture and storage process.
With over 150 CCS projects in advanced development or under construction, compared to under 50 in operation now, the need for specialised insurance is set to increase rapidly.
Howden announced a Scor-led facility at Lloyd’s for CCS facilities in January 2024. Aon launched a product in May after structuring a solution for energy firm and CCS developer Eni UK. WTW wrote about the demand for new CCS insurance solutions in a recent viewpoint article for Sustainable Insurer, while Marsh also says it is developing new covers for CCS risks.
Carbon credit invalidation and reversal risk
Buyers of carbon credits continue to face risks after the carbon offset has been achieved and the carbon credit has been delivered.
In January 2023, an investigation by The Guardian, Die Zeit and SourceMaterial claimed that 90 percent of rainforest carbon credits certified by carbon standards firm Verra did not represent genuine carbon reductions.
Verra disputes this claim, but the dispute highlights the risk that carbon credits could be invalidated after being issued, such as in cases of negligence or fraud. A related risk is reversal, where carbon dioxide that had been removed is released back into the atmosphere by an event such as a forest fire or leakage from a carbon storage facility.
Howden first launched a carbon credit invalidation insurance product in September 2022 in partnership with carbon finance business Respira International. Nephila Syndicate 2357 is providing lead capacity for the product, which covers third-party negligence and fraud.
Oka, a start-up that launched a Lloyd’s syndicate-in-a-box in January 2024, is underwriting insurance for invalidation, reversal and other risks that affect carbon credits after they have been issued.
We2Sure also plans to launch an insurance product protecting buyers of carbon credits against fraud, theft and related losses. This can be used to cover some pre-issuance as well as post-issuance risks.
These products are being distributed primarily through partnerships with those selling carbon credits. For example, Oka’s partnership with climate-focused trading platform Cloverly enables Cloverly to sell carbon credits pre-wrapped in Oka insurance. Companies purchasing the carbon credits are automatically covered in the event that their credit is invalidated or the offset reversed.
Oka CEO Chris Slater told Sustainable Insurer: “With insurance, we’re trying to give buyers confidence that the credits they’re buying can stand behind the claims that they’re making with their net-zero goals. And for developers who are listing their credits on a global platform, it gives them an opportunity to signal to the market that their credits are insured [and that] therefore they are of quality.”
Carbon price fluctuations
Since the price of carbon credits fluctuates over time, there is a price risk involved in insuring them. One solution is to state an agreed value for insured carbon credits in the policy, but this exposes policyholders to a scenario where their insurance payout does not cover the cost of replacing a carbon credit that could not be delivered or was invalidated.
In October 2023, Kita established a “carbon supplier pool” with four carbon offsetting firms. This enables it to pay insurance claims in replacement carbon credits.
Start-up CarbonPool, which has raised $12mn in funding, also aims to provide insurance payouts in carbon credits. It is working to establish the world’s first insurance company with a carbon credit balance sheet and launch policies for delivery, reversal and other risks.
In the words of CarbonPool founder Coenraad Vrolijk: “You can't fix climate change by paying out. The only way you can do that is by having a carbon balance sheet.”
Unintended emissions risk
Even if nothing goes wrong with the carbon credits that a company purchases, it could still miss its emissions targets if it emits more carbon dioxide than it expected as a result of external factors.
For example, poor weather conditions could force ships to take longer routes, use more fuel and produce greater emissions. Factories that primarily rely on green energy could need to switch to traditional, high-emitting energy sources if local solar farms are damaged in a hailstorm and take time to repair.
Axa XL launched excess emissions coverage for its marine clients in July 2023 as an extension to its existing marine hull product. The coverage will pay out with voluntary carbon credits equal to the amount of excess emissions resulting from an unexpected extension to a journey caused by a covered risk.
We2Sure plans to start underwriting unintended emissions policies for corporates in July 2024, covering various sources of unexpected carbon usage and paying the cost of equivalent carbon credits. CarbonPool also intends to launch a similar product.
These products have a similar function to the coverage for CO2 leakage from CCS projects announced by Howden and Aon, which is just one specific case of unintended emissions.
What to expect
The carbon insurance market is still nascent, with the first dedicated products arriving on the market in 2022 and 2023. 2024 will be a key year for the development of a carbon insurance market, with five new products launched already and more to come.
CFC’s Beattie said in a LinkedIn post that the firm has three more new insurance products in the pipeline for its carbon strategy this year. Start-ups Kita, Oka and CarbonPool all plan to launch products across various categories of risk in the months ahead, while Arbol and We2Sure also have carbon-related insurance products in development.
The launch and uptake of carbon insurance products to date has been slowed by changes in the carbon markets themselves, where complexities include the changing role of intermediaries and increased scrutiny on carbon offset certifiers such as Verra.
While a consensus around product categories and scope of coverage may take time, early entrants benefit from a first-mover advantage. Partnerships with prominent carbon market participants, such as those that can integrate insurance into the purchase of carbon credits, will be a key factor in the success of carbon insurance products.
With several deals already announced, insurance companies are discussing these partnership opportunities with carbon firms now. Those that can establish long-term relationships with the companies that will dominate the carbon markets of the future are the best placed to succeed.
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