Voyages of Value: Insurance's Role in the Carbon Credit Expedition

As the impacts of climate change and the biodiversity crisis become more real, the potential role of insurance in supporting innovative industries has never been more crucial. Historically, insurance has enabled the exploration and development of new frontiers, from maritime ventures during the Age of Exploration to the industrial enterprises of the 19th century. Today, as we embark on the exploration of the nature-based economy and carbon credit markets, insurance once again stands at the forefront, offering a robust framework to mitigate risks and enhance financial stability. But what is the role of insurance in the carbon credit markets, how can it help and is it even possible to buy insurance for carbon credits?

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The Role of Insurance Supporting Innovation

Throughout history, insurance has been a useful tool in helping support the development of innovative and adventurous industries and businesses. In fact, the evolution of the modern insurance industry can be traced back to the age of global exploration and the Lloyd’s Coffeehouse in London.

During the 15th and 16th centuries, European explorers set out on perilous voyages to discover new lands and trade routes. These voyages were fraught with dangers such as shipwrecks, storms, and piracy. To mitigate these risks, maritime insurance became more sophisticated. The rise of Lloyd’s Coffeehouse in London in the late 17th century played a pivotal role in the development of modern marine insurance by providing a gathering place for merchants, shipowners, and insurers to discuss and underwrite maritime ventures. This laid the groundwork for the extensive insurance practices that would eventually support global exploration and trade.

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The Evolution of the Insurance Industry

?The evolution of the insurance industry from the Lloyd's of London coffee house to its present-day form is a fascinating journey marked by innovation, regulation, and technological advancements. As trade expanded, so did the need for more sophisticated risk management tools, leading to the formation of the first modern insurance companies in the late 1600s following the Great Fire of London.

?From these early days, the insurance industry evolved significantly through the Industrial Revolution, which introduced new types of risks associated with emerging industries like railroads, manufacturing, and mining.

?This period saw the development of various insurance products, including life, health, property, and casualty insurance. Then the 20th century brought about significant regulatory frameworks to ensure the solvency and reliability of insurance companies, alongside advancements in actuarial science that improved risk assessment and pricing.

?The digital age further transformed the industry with the advent of the internet, allowing for direct online sales and streamlined claims processing.

?Today, innovations such as artificial intelligence, big data, and blockchain technology continue to revolutionise the industry, making insurance more accessible, efficient, and more inclusive including offering an important role in the risk management of natural capital.

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The Age of Carbon Credit Exploration

We’re very much in the age of exploration of the nature-based economy, it’s therefore not surprising that the risks faced by the nautical pioneers are similar to the ones we are working through today. In the age of exploration, risks centred around shipwrecks, storms, and piracy whereas the biggest risks for carbon credits include catastrophic climatic events (storms and wildlife fires), delivery (including additionality and permanency) and credit quality (integrity and impact).

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Existing Approaches to Risk Management

In the UK the Woodland and Peatland Carbon Codes require project developers to provide a buffer (usually around 20% of total carbon credits produced). This is intended to act as a risk management mechanism designed to protect the integrity of carbon credits by compensating for potential carbon loss due to unforeseen events such as natural disasters, disease, or fire. The exact size of the buffer is determined by a comprehensive risk assessment of factors like location, tree species / restoration methods, and management practices. This pooled buffer account acts as a safety net, ensuring that any carbon loss across all WCC-certified projects can be covered, thereby maintaining the reliability of the carbon credits in circulation.?

If a specific project experiences carbon loss, credits from the buffer pool are used to cover the deficit, ensuring that the overall environmental benefits promised by the projects are preserved. This system provides assurance to investors and buyers that their carbon offsets remain valid and represent genuine carbon sequestration efforts. The buffer mechanism is crucial for upholding the credibility of the Woodland and Peatland Carbon Codes and its certified projects.

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Limitations of the Existing Approaches

The buffer approach in the Woodland and Peatland Carbon Codes, while providing an important safety net for carbon credits, has several drawbacks. One significant issue is the reduced financial incentive for project developers, as a relatively large portion of their credits must be diverted into the buffer pool, impacting immediate financial returns and cash flow. This can be particularly challenging for smaller projects or those with tighter budgets. Additionally, the process of determining appropriate buffer contributions through comprehensive risk assessments can be complex and resource-intensive, potentially leading to inconsistencies and perceptions of unfairness among project developers.

Moreover, the buffer system is beginning to present inefficiencies, such as accumulations of surplus credits in the buffer pool, which represent an inefficient use of resources that could otherwise be invested in further conservation efforts.

There are also costs associated with managing and administering the buffer pool. Transparency concerns regarding how the buffer pool is managed and used can lead to trust issues among stakeholders.

In terms of perception, the existence of such large buffers may be influencing options that carbon sequestration projects are inherently risky or unreliable, undermining confidence in the projects and the broader carbon market.

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The Potential Advantages of Insurance

?The insurance industry could potentially provide a more efficient and flexible solution compared to the buffer approach for managing risks in carbon sequestration projects. An insurance back approach would allow project developers to sell all their credits immediately, improving cash flow and financial returns. Insurance premiums can be more predictable and potentially lower than the opportunity cost of contributing to a buffer pool, allowing for better budget management.?

Additionally, insurance policies can be tailored to specific project risks, providing more precise and comprehensive coverage compared to a one-size-fits-all buffer system. This customisation, combined with professional risk assessments by insurance companies, can enhance the reliability and accuracy of risk management.

The involvement of reputable insurance companies can also enhance the credibility of carbon projects, boosting market confidence by providing an additional layer of assurance that the carbon credits are backed by reliable risk management. There are of course risks associated with carbon credits and we need the best minds focused on developing tools and techniques for managing these risks.

Insurance policies offer clear terms and conditions, ensuring transparency and accountability, which can reduce disputes and build trust among stakeholders. Furthermore, using insurance can reduce the administrative burden on project developers, as risk management responsibilities are transferred to the insurance provider. This allows developers to focus more on their core activities, making insurance a potentially more efficient, flexible, and credible solution for managing carbon sequestration project risks

?In the same way that we worked with Triodos to make natural capital a bankable assets class, the involvement of the insurance industry is another key step in the professionalisation of the nature-based economy.

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Can You Even Insure Carbon Credits?

Yes, it is now possible to buy insurance for carbon credits. Several companies offer specialised insurance products designed to cover the risks associated with carbon credit transactions. These products provide coverage for a range of risks, including non-delivery of carbon credits, fraud, and third-party negligence, which are critical for enhancing confidence in the voluntary carbon market.

For instance, Howden has introduced the first-ever voluntary carbon credit insurance product, which aims to add an additional layer of security by covering third-party negligence and fraud. This product is developed in partnership with Respira International and Nephila Capital, and it helps ensure that buyers of carbon credits can trust that their investments will deliver the promised carbon reductions

?US-based insurer Oka, working in partnership with the leading digital carbon credit trading platform Cloverly now allows buyers to add insurance at the point of purchase initially covering a fixed period of the first three years of the product.

Similarly, Kita, a UK-based pioneering insurance startup, offers Carbon Purchase Protection Insurance, which safeguards buyers of forward-purchased carbon removal credits against the risk of under-delivery. This product is particularly important for maintaining investor confidence and stimulating growth in the carbon credits industry. We had the pleasure of welcoming Natalia Dorfman (Co-Founder and CEO) on the Shoot Room Session Podcast recently to hear more about their journey.

These insurance solutions are essential for scaling the carbon market, providing financial stability, and ensuring that high-quality carbon projects receive the necessary funding to achieve global net-zero targets.

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What does this mean for Oxygen Conservation?

We’re committed to offering world-leading high-quality, nature-based, carbon credits. Our credits are generated from meticulously designed landscape restoration projects, such as reforestation, afforestation, and peatland restoration, all adhering to stringent standards like the Woodland Carbon Code and Peatland Code. These projects are all UK-based on land we own and manage. They not only sequester significant amounts of carbon dioxide but also enhance biodiversity, improve water quality, and support local communities.

We believe that alongside independent monitoring, reporting and verification, insurance offers a key pillar in providing the transparency, auditability and confidence required to see the successful growth of the carbon credit market.

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Insuring the Future

?As we navigate the uncharted seas of carbon markets, it is clear that we face many challenges and uncertain risks. The future development of the nature-based economy and carbon credit integrity lies in our ability to innovate beyond traditional mechanisms.?

The buffer approach, while foundational, shows limitations in financial efficiency and administrative complexity. On the other hand, the advent of carbon credit insurance offers a significant evolution, offering tailored, transparent, and professionally managed risk mitigation.

?The insurance model not only promises greater financial returns and stability for project developers but also insists upon a higher degree of trust and credibility among investors and stakeholders. This is crucial for the growth and scaling of high-quality carbon projects that are essential for achieving global net-zero targets. By transferring risk management responsibilities to specialised insurance providers, developers can focus more on enhancing the effectiveness and impact of their projects for people and wildlife.

?As we sail forward, the adventurous spirit that once safeguarded ships and cargo now empowers us to protect our planet, transforming scepticism into trust and potential into action. With the wind of insurance at our backs, we are better equipped to navigate the turbulent seas of climate change and reach our collective destination of a sustainable future.