The Role of Insurance in Carbon Credit Markets
We look at the role of insurance as a means of mitigating the risks associated with the Carbon Credit Markets
The Role of Insurance in Carbon Credit Markets
Carbon credits are tradable permits that can be bought by organisations to offset their carbon dioxide (CO₂) or equivalent greenhouse gas emissions. These credits are generated by projects that reduce or remove emissions, such as reforestation, renewable energy development or methane capture, and can be traded in both compliance and voluntary markets. One carbon credit is equal to one tonne of C02 that has been reduced, avoided or removed from the atmosphere.
While carbon credits provide an effective solution for companies to offset their emissions, there are many risks. Here, we look at the role of insurance as a means of mitigating the risks associated with the Carbon Credit Markets.
Compliance and voluntary carbon markets
The Compliance Carbon Market (CCM) is a ‘cap and trade’ system, with caps placed on the amount of emissions permitted from a sector or company and is subject to robust regulation. The Voluntary Carbon Market (VCM) is driven by the growing demand for organisations to decarbonise and offset their emissions, and is less regulated and guided by non-government standards.
Carbon credits can be traded in compliance markets to meet regulatory requirements or in voluntary markets to support corporate sustainability initiatives. The risks associated with the VCM can materialise at any stage of a carbon project’s lifecycle and are mostly transferred from one market participant to another. They are also directly affected by such external factors as natural catastrophes, fraud, crime, corruption, government intervention and legal and regulatory change.
The role of insurance
While carbon credit markets hold significant potential in addressing climate change, there are many risks and uncertainties that could potentially hinder investment and undermine confidence. Amidst a shifting landscape and a lack of data, insurance provides a powerful de-risking tool for project developers and credit buyers, providing cover against the failure to deliver credits and thereby empowering more organisations to enter the voluntary carbon market. As such, insurance should play an integral role in the planning process.
Risks Addressed by Carbon Credit Insurance
Insurance policies in carbon credit markets typically cover risks that may affect projects or credits. By addressing the risks, insurance can help developers and buyers avoid financial losses and operational setbacks. Risks include:
- Reversal Risk: loss of stored or reduced carbon due to events like wildfires, floods, or deforestation.
- Underperformance: projects producing fewer credits than planned because of technical or operational challenges.
- Invalidation: credits becoming invalid due to errors, fraud, or non-compliance with standards.
- Political Risk: disruptions caused by policy changes, political instability, or expropriation.
- Force Majeure: unforeseen events, such as natural disasters or pandemics, that prevent project completion.
- Fraud and Misrepresentation: misleading claims about a project’s carbon reduction or removal capabilities.
- Market Volatility: price changes or market downturns impacting project revenues or credit values.
Benefits for Project Developers
Insurance provides project developers with financial security and operational confidence, protecting against such risks as natural disasters, pest outbreaks, and political instability, with pay-outs either as financial compensation or replacement credits. Cover also offers protection against delays or interruptions that could disrupt cash flow or credit issuance timelines, thereby ensuring revenue stability.
In addition, insured projects are also seen as more reliable, attracting investors and buyers, thereby increasing credibility; and provide buffer pool support for nature -based projects, helping to cover losses without relying entirely on buffer pools, helping to preserve the project’s long-term viability.
Benefits for Credit Purchasers
Buyers of carbon credits also benefit from insurance by reducing any risks related to credit performance. This includes Fraud and Integrity Protection, ensuring that purchased credits represent legitimate emissions reductions or removals; and Compliance Assurance, guaranteeing financial compensation or replacement credits in the event that purchased credits are invalidated or underperform. (This means that in cases where carbon credits are required to meet compliance obligations, the organisation is not rendered non-compliant.)
Other benefits include Long-Term Risk Mitigation, providing assurance that credits will remain valid throughout the project’s lifespan, even in the face of unexpected risks; and Market Confidence, helping to build trust in the market, enabling buyers to confidently meet sustainability goals or regulatory requirements.
Claims Settlement Options
Insurance for carbon credits offers flexibility in how claims are settled, depending on the specific policy and circumstances. In terms of monetary compensation, the value of invalidated or underperforming credits can be reimbursed. Settlement can also provide replacement credits, whereby equivalent credits can be provided to maintain compliance or offset goals without financial loss.
Talk to PIB
Insurance helps make carbon credit markets more reliable by managing risks for both developers and buyers. It protects projects from setbacks, ensures buyers get what they pay for and are less exposed to risks outside their control, and builds trust in the market. To find out more about Carbon Credit Insurance, safeguarding the purchase of carbon credits and providing protection against potential non-delivery risks, please talk to our dedicated team, call us on 0330 058 9863 or email using the button below.