The insurance sector cannot ignore carbon markets
Good risk management starts with understanding the exposures that come with carbon credits.
Voluntary carbon markets are still nascent, yet they’re providing key avenues for organizations worldwide to offset carbon emissions and help combat the negative impacts of climate change.
The potential of these markets is vast. By the end of 2024, their value is projected to reach $3 billion, while Barclays predicts carbon markets could explode to a colossal worth of $250 billion by 2030.
But it’s not all been smooth sailing so far. That’s because the projects themselves can be fraught with significant risks, causing a series of high-profile failures that are threatening to deter participation in these markets — a trend that insurance has the capability to step in and help resolve.
Currently, we have two opposing forces: On the one hand, a growing sense the voluntary carbon market, while imperfect, has a future as a critical tool in the fight against dangerous climate change; and on the other hand, carbon projects’ inherent risks.
As these forces converge, they create fertile ground for insurance providers to take up. Organizations need a way of making safe their investments in carbon credits, and the insurance sector’s financial collateral and understanding of these risks is the perfect formula for providing that mechanism, helping to drive the carbon transition for a more stable future.
Carbon credits: From risks to opportunities
Purchasing carbon credits is an efficient method of supporting environmental projects — be it planting new forests or developing more sustainable energy sources — and therefore contributing in the fight against climate change. But these carbon credits are a synthetic investment tied to science being undertaken at a physical location.
This means projects can be disrupted by natural catastrophes, political risks, fraud, even bankruptcy; risks that can ultimately lead to the under-delivery of credits and leave the investor out of pocket and with nothing to show for it. Certain risks can be transferred via contracting, but external risk factors over which neither party has control are a massive problem for counterparties. These risks can hold up deals, or prevent them from happening at all.
In a high-profile case that rocked the carbon world, the Rimba Raya Biodiversity Reserve Project first stalled back in 2022 when Indonesia banned the export of carbon credits due to a dispute over tax payments by the project operator. The project then ran into licensing issues, putting regulatory risks into the spotlight.
More recently in Brazil, three projects were suspended after a police investigation into greenwashing, leaving its investors exposed to under-delivery risk. It’s little wonder that a recent CFC survey found that 75% of respondents were ‘very concerned’ of delivery shortfall, with 85% stating they would be ‘very likely’ to consider buying under-delivery insurance.
For an insurance sector used to dealing with such issues, the risks present in these projects are nothing new. Yet despite this knowledge and the urgent need for a de-risking mechanism, the sector is only just beginning to try its hand at packaging these risks into carbon products; the result being the majority of this year’s $3 billion in trading activity will go uninsured.
Strong foundations: What voluntary carbon markets need to succeed
History shows that insurance plays a vital part in facilitating activities where significant risks exist. In other words, without cover it’s often the case that business activity doesn’t happen.
If we’re to turn the tide on climate change then we must make use of every channel available to us. The US government’s recent backing of voluntary carbon projects shows how they are an important tool for channeling significant private capital into this fight, and so deserve our focus to support and improve.
For voluntary carbon markets, it’s about identifying high-quality projects doing proper science and delivering climate value, and giving these projects the support they need to succeed. Robust market infrastructure and better measuring standards are just two ways we can start to mitigate risk and establish high standards. It’s not a case of rubber-stamping projects with our seal of approval. But insurance can be an important proxy for quality that market participants look for when planning what credits to buy. This is a huge and important responsibility.
A new frontier: Seizing the carbon opportunity
The breadth of organizations considering carbon credits as a means of offsetting emissions is inspiring. However, over time, it’s likely that companies of all sizes will be compelled by law to engage with the carbon credit market in order to reduce unavoidable emissions, as the climate disaster gets worse and governments are compelled to act.
Good risk management for these organizations starts with understanding the exposures that come with carbon credits. Once insurance is presented as an effective option of mitigating risk, we firmly believe the carbon insurance market has the potential to one day outgrow cyber as another key systemic risk, one that the world faces and the insurance industry needs to work out how to help solve.
CFC is a specialist insurance provider in emerging risk and cyber. If you’d like to learn more about the carbon opportunity, I recommend reading our new carbon report. It contains key stats that reveal the current state of play and the demand for insurance products.
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