Insurers Are Working to Shore Up the $2 Billion Carbon Offset Market

By | May 24, 2024

Data fraud, questionable accounting practices and intensified catastrophes are just some of the issues that have battered the voluntary carbon market.

Those misfortunes have helped spur a new line of business: Insurance policies designed to de-risk credits that polluters buy to neutralize their climate impact. Whether insurance can help stabilize an industry under heavy scrutiny remains to be seen, though.

Carbon credits are a financial instrument to help channel capital into projects that cut greenhouse gas emissions. Project developers sell credits equal to one ton of carbon dioxide reduced or avoided to polluters who want to cancel out emissions. But some projects — particularly forest projects — have been shown to benefit the climate much less than promised, often because the forests were not at risk of being cut down in the first place.

In the latest sign of the fledgling insurance industry’s growth, Park City, Utah-based insurer Oka teamed up with Cloverly, a carbon trading platform, to offer insured credits earlier this year. Cloverly’s 300-strong corporate users can purchase a policy to go with carbon credits traded on its digital marketplace, not unlike how consumers can add an extended warranty while shopping for a new phone, according to the company.

If part of an insured forestry project burns down in a fire, for instance, Oka would pay the policyholder for the value of the lost carbon credits. Cloverly, headquartered in London and Atlanta, Georgia, has yet to invalidate credits since its inception in 2019, according to Chief Executive Officer Jason Rubottom. Still, Rubottom says he wasted no time contacting Oka after learning about the company.

Insurance is a “necessary solution to scaling this market with integrity,” Rubottom says. “There is uncertainty and risk in any carbon credit. There is no way to avoid it. It is more about minimizing and mitigating [that risk].”

Global demand for offsets last year hit a new record, with polluters buying credits to counterbalance as many as 164 million tons of CO2 emissions, according to market research firm BloombergNEF. Purchases could increase to billions of tons annually and be worth $1.1. trillion by 2050 — as long as investors remain confident, BNEF analysts wrote in a recent research note.

The mechanism once fueled the global energy transition, when wind power and solar energy struggled to compete with fossil fuels in cost. But carbon offsets have drawn criticism in recent years for failing to deliver meaningful climate benefits. Climate change has made matters worse, with worsening wildfires damaging projects intended to sequester carbon for decades to come.

Carbon credit insurance is “essential” to keep investors engaged, says Natalia Dorfman, co-founder and chief executive officer of Kita Earth, a UK-based insurance startup. “Getting millions of dollars into underlying [offset] projects is challenging without the risk mitigation of insurance.”

As insurers are incentivized to put carbon offset projects under scrutiny and underwrite the ones with lower risks, Dorfman says insurance could also bring an “additional stamp of confidence” to the troubled carbon market.

Some project developers agree. One such firm is GECA Environnement, a Canadian company that manages a biochar carbon removal project in the US and purchased carbon credit insurance from Oka.

As it is “excessively difficult” for buyers to navigate the carbon offset market, insurance presents a “good opportunity” to offer reassurance, says Melissa Leung, a director at GECA Environnement. While the developer is still testing the new service, Leung says the additional layer of protection has helped.

“It is bringing a whole different product to the table,” says Leung, whose team recently executed their first transaction of insured credits.

“Insurance is there to really enable risk and enable new innovations,” says Chris Slater, an insurance veteran who founded Oka in 2022. “In the carbon market, it is an important missing part at the moment.”

Most traditional insurers have steered clear of offering carbon trading coverage, citing concerns about the lack of quality data to assess risks, the impact of an increasingly unstable climate and the fact that many projects are located in countries with weak legal systems.

“Those short-term policies don’t solve the long-term risks, even if they help parties manage short-term risks in a more efficient way,” says Danny Cullenward, a climate lawyer and a senior fellow at the Kleinman Center for Energy Policy at the University of Pennsylvania. “It is not an answer, and can never be an answer to climate-induced risks.”

To date, buyers and sellers of carbon credits have largely relied on a self-insurance practice known as the “buffer pool,” where project developers put a portion of credits aside to cover unexpected carbon losses. However, the more credits the developers channel into the buffer pool, the fewer are left for sales, weighing on project profitability. Insurers say they can provide similar benefits with lower costs.

To develop its product, Oka says it has collected data from about 7,000 carbon offset projects of all sorts worldwide and 15 major perils ranging from wildfires to fraud and operational negligence. The startup analyzed the frequency and severity of each peril and combined that with other factors such as a project’s location, developer experience and buffer pool size to create a pricing model.

Since it received the greenlight from Lloyd’s of London to begin underwriting policies in January, the company has provided quotes to roughly 50 carbon market participants and completed “a number of sales,” according to Slater. Oka also raised $10 million in venture funding in March from investors including Aquiline Capital Partners and Firstminute Capital.

Rubottom says Cloverly itself has purchased Oka’s policies for two nature-based offset projects in Indonesia to understand how the insurance works. While he declines to specify the premium, Rubottom says “it is very reasonable,” adding that how affordable the insurance was “surprised” him.

Oka isn’t alone in the nascent field. The Multilateral Investment Guarantee Agency (MIGA) — the World Bank’s insurance arm — is working on creating policies for offset project developers to hedge against political risks. (Zimbabwe’s announcement last year that it would retain half of offset revenues generated on its soil shows the challenges developers face.) Kyoowon Oh, a senior underwriter at MIGA, says that his agency plans to roll out two or three pilot projects in Asia and Africa this year.

Other pioneers include Howard Group, a broker that manages more than $38 billion in insurance premiums. Since 2022, Howard has partnered with carbon finance firm Respira International and reinsurance investor Nephila Capital to provide insurance coverage for third-party negligence and fraud.

For its part, Kita has an insurance solution to help mitigate uncertainty of delivering carbon credits on time. For instance, if a carbon credit registry — that is, a third party that registers offset projects and certifies credits — changed its methodology before credits are delivered, Kita policyholders could claim cash compensation and buy carbon credits elsewhere, according to the insurer. Buyers could also receive replacement credits from projects Kita has pre-selected.

Since the launch of its product last year, Kita has received hundreds of inquiries from prospective policyholders, Dorfman says, though she declines to disclose the number of completed deals.

As virtually no claims have been made so far, carbon credit insurance’s real-world impact remains to be seen. But some observers are skeptical of the benefits.

“The pricing is really a problem here,” says Juerg Fuessler, a managing partner at Zurich-based consultancy Infras. He says providing comprehensive coverage for forestry projects in areas with high wildfire risk, for example, could result in premiums too high for anyone to buy a policy. For projects where premiums are lower, their risk levels are usually lower and so is the attractiveness of insurance, Fuessler says.

Erratic weather patterns and the emergence of novel emissions reduction solutions are two factors that could further complicate the matter. That’s because the success of insurance is largely built upon how accurately insurers can predict the damage they might have to cover and price their service accordingly. But climate change is shifting the odds of certain extreme events, making pricing for nature-based offset projects a challenge. While engineered carbon removal projects such as direct air capture are more insulated from weather perils, the technologies are still in their infancy and lack sufficient data for insurers to develop a meaningful model.

How insurers address disputes over whether a project delivered actual carbon benefits — so-called additionality — is also still under development. In theory, a project is additional if the emissions reduction or removal would not have occurred without revenue from the sale of offset credits. But that remains hard to measure.

“It is very difficult to write insurance products when key market actors don’t agree on either the objective indicator of what an outcome would be or what the appropriate remedy is,” Cullenward says.

But among all the wrinkles insurers have to work through, the biggest might be a policy’s expiration date. For offsets to be meaningful, project developers have to keep carbon out of the atmosphere for a long period, typically a century or more. Yet no existing insurance policies include a 100-year coverage period.

“Insurance can’t play a role in guaranteeing permanence,” says Slater. Instead, Oka offers a three-year policy and could renew it after re-assessing risks and adjusting premiums. By doing that, “we’re taking a bite-sized chunk at some of the permanence,” he says.

But Cullenward likens the short-term arrangement in carbon credit insurance to home insurance that has a similar renewal procedure. In US states such as California and Florida, worsening wildfires and hurricanes are driving away home insurance providers. The same could be true for the carbon credit industry, and Cullenward wonders how long a forestry offset project developer could renew their policy — and at what price.

Nevertheless, Rubottom of Cloverly says he welcomes the arrival of insurance innovation as “another important piece to the puzzle.”

“Carbon credit trading is a very early and very immature industry,” he says. “There’s no silver bullet.”

Photo: If part of an insured forestry project burns down in a fire, for instance, Oka would pay the policyholder for the value of the lost carbon credits. Photographer: Max Whittaker/Bloomberg

Topics Trends Carriers

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