More insurers than ever are realizing the potential value of carbon markets. The insurance industry’s involvement in the voluntary carbon market is key in driving its growth and sustainability, and a powerful tool for de-risking the market. But what exactly does it insure? In this article, we explain what carbon insurance is and whether it’s the next big thing for the insurance industry.
Carbon Markets: What are they?
Carbon markets are trading systems in which carbon credits are sold and bought. The carbon market is designed to revamp heavily polluting sectors while channeling investments into decarbonization endeavors. By purchasing carbon credits from entities that remove or reduce greenhouse gas emissions, businesses can help meet their regulated pollution limitations. A carbon market also allows investors and corporations to trade both carbon credits and carbon offsets simultaneously. This system has evolved to include both compliance (regulatory) and Voluntary Carbon Markets (VCM). Each market plays a significant role in reducing global emissions. VCMs are decentralized markets in which individuals or organizations buy credits to voluntarily offset their carbon footprint.
What are carbon credits?
A carbon credit is a financial instrument that measures how much carbon dioxide an initiative, such as reforestation, mangrove restoration, or direct air, captures from the atmosphere over time. Each credit is equivalent to cutting one metric ton of CO2 or an equivalent greenhouse gas. Companies buy credits to “offset” their emissions. Credits are bought from project developers engaged in projects that remove or reduce carbon or greenhouse gases (GHGs). Projects range from small community-based activities such as clean cookstoves to large industrial-style projects, including high-volume hydro plants and commercial reforestation. Project developers or companies can sell their carbon credits directly to buyers or through a broker. They can also sell their credits to a retailer, who can then resell them to a buyer.
So, what is Carbon Insurance exactly?
Carbon insurance is an emerging green financial instrument. It makes significant differences in spreading the failure risk of innovative but immature carbon reduction technology. This ensures enterprises for low-carbon transition. A carbon insurance supply chain includes a manufacturer and an insurer.
How Carbon Insurance works
A manufacturer produces and sells a product to its customers. To reduce carbon emissions and thus, save costs under a cap-and-trade mechanism, the manufacturer invests in a new carbon reduction technology and purchases Carbon Insurance from the insurer to hedge the failure risk. Carbon Insurance can lower the manufacturer’s entry barrier to green investment. Carbon Insurance attracts more firms, especially small and medium-sized enterprises, to adopt carbon reduction technology. In turn, the manufacturer buying Carbon Insurance produces more products and earns more profit than not buying.
The Need for Carbon Insurance
To understand the increasing demand for Carbon Insurance to help mitigate risks associated with the VCM, CFC Specialty Insurance surveyed 549 wholesalers, investors, corporate buyers, and project developers in Canada, the U.K., and the U.S. These organizations already operate in the voluntary market. The survey found:
- 75% of existing buyers are ‘very concerned’ about delivery shortfalls
- 65% have experienced losses from non-delivery
- 80% say they are very likely to consider purchasing under-delivery insurance
- 50% of non-buyers say they would be more inclined to purchase voluntary carbon credits if they could insure them against non-delivery risk
Three main concerns that Carbon Insurance addresses
Carbon Insurance providers are emerging to create policies that address three main concerns:
- Fraud and negligence: Relating to how companies can disclose claims against their corporate commitments and meant to protect brand reputations.
- Political risk: This includes regulatory changes that affect who can use offsets. For example, when a government decides offsets should be used against pledges or can’t be “exported” or accounted for elsewhere.
- Issuance failures: When a project fails to deliver credits within a certain timeframe.
At the end of 2022, the voluntary carbon market was worth close to $2 billion, according to Ecosystem Marketplace. Data shows transaction values fell dramatically last year to an estimated $343 million at the end of November.
The insurance sector’s role in the climate transition
From insuring renewable energy projects to covering sustainable agriculture practices, insurance is uniquely positioned to make a real, positive difference in this space. The sector’s involvement not only helps to stabilize and secure climate transition processes but also sends a strong signal to the market about the viability and importance of sustainable practices. As businesses become more involved in the carbon market, insurance should be an integral part of their planning process. By safeguarding the risks associated with the carbon market, insurers can play a vital role in facilitating the growth of sustainable projects. There’s an important role for the insurance industry to play in the climate transition and has found new risk solutions that will enable capital to flow into the carbon market.
Carbon Insurance on the rise
One goal of insurers is to help expand the overall market for credits linked to carbon dioxide removal or emissions avoidance, which isn’t growing quickly enough to meet anticipated future demand, according to some predictions. “Look at the cyber market now in insurance — it’s the new big thing,” says George Beattie, head of innovation at CFC. “Carbon will be the same in a shorter period.” However, the compliance program appears to be the approach Canada is taking. With the federal government placing a price on carbon pollution, those producing carbon emissions can purchase credits annually from a shrinking pool of allowable credits. In doing this, those emitting carbon are forced to change their practices before the pool of credits runs out.
The VCM will probably be worth $30 billion by 2030 and $1 trillion by 2050. By comparison, the global cyber market is estimated at more than $200 billion, according to various sources.
In contrast, in the voluntary market, organizations offset their emissions by purchasing carbon credits from projects that demonstrate a reduction in carbon emissions. According to Beattie, the voluntary market was valued at $2 billion last year and will be $3 billion this year. “The long and deep bet…that carbon will be bigger than cyber in the future is that this market feels inevitable,” he says. “If you buy into this idea that human activity is aiding global warming and that we’re going to see worse catastrophes, the human pressure piece on government is inevitable. And one of the only things that government can do in response to that pressure is to regulate.”
Canada’s Part in VCMs
Many analysts feel that Canada will have a large role to play in the VCM going forward because of the country’s natural assets, including forests and soil. “Canada is where a lot of the action is going to be in the market,” Beattie says. Many feel that there is an economic opportunity for Canada and Canada-based brokers and underwriters. Beattie believes that “It’s probably even bigger than cyber was because the activity will be happening on a primary basis in Canada. “[Former U.S. secretary of state] John Kerry said the carbon market will be the biggest market the world’s ever seen. And a big piece of it will be Canadian.”
Carbon Insurance: Final Thoughts
Global warming is causing catastrophes, the likes of which have never been seen. The public is putting pressure on its governments to “do something about it,” resulting in private industry regulation. “The insurance market will have a fantastic role at quite an early stage in the market’s growth,” says CFC’s Head of Innovation. As companies increasingly demand means to manage risk in their investments in the carbon market, it is fair to expect carbon insurance will become more sophisticated and commonplace in decarbonization plans, a key piece of the path to net zero emissions worldwide.
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