Carbon credits have quickly developed into a multi-billion-dollar market as businesses have made net-zero emissions commitments, but the (re)insurance sector must play a bigger role in mitigating transaction risk and concerns over the integrity of offsets through risk transfer solutions.

Michael Sheren Natalia Dorfman Glenn O Halloran

Speaking at the Risk Mitigation Forum, hosted by RenaissanceRe in partnership with ClimateWise, Natalia Dorfman, CEO and co-founder of carbon insurer Kita, said carbon credits are seen as a crucial part of plans to limit global warming but that increased support from the (re)insurance sector is needed to scale up the nascent industry. 

Carbon credits – which each represent a tonne of carbon either avoided or removed from the atmosphere – are currently available through two markets: the regulated “compliance” market and the unregulated voluntary market. 

The compliance market, also called the cap-and-trade market, measures greenhouse gas emissions and requires companies to buy additional allowances when they over-pollute, while companies with low emissions can sell their extra allowances to larger emitters. 

Dorfman said the compliance market – estimated to be $261bn in 2020 – is seen as a “safer” place to transact business. She said that insurance products “have existed for years” to protect investors and also the practices used to offset carbon emissions, such as renewable energy investment and carbon capture. 

Natalia Dorfman PQ

In contrast, the voluntary carbon market (VCM) has been described as the ‘wild west’, Dorfman said, adding that a lack of transparency and consistent risk management has led to significant transaction risk with companies reluctant to spend millions of dollars on credits for fear of being misled. 

Dorfman also said it is harder for firms to assess the quality of the carbon credits within the VCM, which raises negligence and greenwashing risks for buyers. 

“That risk holds back a lot of companies, because if it’s hard to assess quality, then how do you know that you’re getting quality and how do you know if you’re getting a valid carbon credit? This is one of the spaces where insurance has a role to play.” 

Dorfman added: “We think insurance is a critical enabler to help drive and finance these high quality carbon projects out there which can really help fight the climate crisis, but can also help these large companies achieve their net-zero strategies and really capitalise on the opportunities in this space, and in what is really new asset class.” 

The opportunity for the (re)insurance sector in the VCM is vast, Dorfman noted. Dorfman’s own company, Kita, insures “carbon delivery risk” to enable carbon removal solutions to scale. It provides coverage for carbon units sold on the VCM, enabling greater flows of upfront financing for carbon removal solutions. 

Various estimates suggest the VCM could be worth between $20bn and $50bn by 2030 and in excess of $1trn by 2050. Trading turnover on the VCM has increased to just under $2bn in 2022. 

Voluntary-carbon-market-size-by-value-of-traded-credits,-pre-2005-to-31-Dec-2021

While a total of 60 percent of Fortune 500 companies have now set climate targets and these commitments point to substantial increases in demand for voluntary carbon credits, Michael Sheren, vice chair of the Banking Environment Initiative at the University of Cambridge, said the VCM remains complex, particularly for new buyers.

Highlighting the potential growth in the VCM and the opportunity that exists for the global (re)insurance sector, Sheren said the Bank of England and the OECD both estimate that the price of carbon could touch roughly $100-$130 per tonne. 

“If you take a look at this $50bn market and then you include the data on carbon pricing, I think that shows you what type of market you’ve got here and just how large the market could potentially become,” he said. 

“This will be the biggest commodity market in the world by 2050. And it’s something that the insurance market should get involved in, because it’s got a real place to play in this area, not to just sort of enable it, but actually to take some of the risk off the table.” 

Michael Sheren PQ

Traditionally, insurers have shied away from offering cover for credits tied to carbon offset projects, given the lack of quality data on historic losses and with many projects based in countries with weak legal systems and limited recourse if problems occur. 

But Sheren – who also serves as a senior advisor to the Bank of England on critical risk, governance and operational matters within financial markets and co-chaired the G20 Sustainable Finance Study Group with China – stressed that the insurance sector already provides products for many of the risks which face the carbon credit market and the carbon offset initiatives behind them, such as cover against forest fire or political risk. 

He added that the sector could be more innovative in the way it develops and packages these products so that they meet buyer demand but also fit within an insurer’s own risk tolerances.

Glenn O’Halloran, executive director, environment and climate risks at Howden, noted that the insurance market is currently “at the beginning of its journey” within the carbon credit markets. 

“Insurers are tripping over themselves strategically to get into this space,” he explained. “We all know that we need to do something and we do have existing products in the market which can help cover some of those risks.” 

To help speed up the growth of the industry, Howden in September teamed up with carbon finance firm Respira International and Nephila Capital to provide cover for third-party negligence and fraud, reducing the potential reputational risk of buying carbon credits. 

O’Halloran said such products are essential to bring confidence to the carbon credit market. He said insurance backing for carbon credits has the potential to help verify quality projects and to remove the transaction risk for both buyers and sellers. 

Glenn O Halloran PQ

“At the moment, they see insurance as an enabler. Once insurers get involved and provide risk transfer and sensible insurance products that de-risk these transactions, you get a market that becomes much less lumpy and it takes the friction out of the transaction. 

“Insurance can ensure that the buyer or seller has confidence going into the deal. That’s how we think insurance has a role to play.” 

First launched in 2008, RenaissanceRe’s Risk Mitigation Leadership Forum is designed to advance the disaster safety movement in a collaborative way and develop strategies that foster community resilience. 

Titled “Leading the Transition to a Green Economy: Role of Credit & Risk Transfer”, the 2022 forum explored topics such as the advancement of renewable energy adoption through credit financing, the role of credit risk transfer in helping organisations meet net-zero commitments, ways to better quantify climate risks and solutions to reduce carbon intensity in the housing market.  

Over the next few days The Insurer will be publishing more content from the event, including video highlights and interviews with Cathal Carr, SVP and global head of climate and sustainability strategy at RenaissanceRe, Dr Nina Seega, research director at the Cambridge Institute for Sustainability Leadership, Jeff Manson, SVP underwriting and head of global public sector partnership at RenaissanceRe, and Fiona Walden, global head of credit at RenaissanceRe.

More on the carbon credits market… 

Michael Sheren, vice chair of the Banking Environment Initiative at the University of Cambridge, goes into a bit more detail for us in an exclusive interview with The Insurer TV, helping to explain this relatively new marketplace and the significance of carbon offsets. 

Sheren discusses: 

  • What you need to know about the carbon credits market, looking at both the opportunities and challenges 

  • How credit (re)insurance can help scale solution for carbon markets and transition risk

  • How to price the risk and get comfortable with it

  • The outlook for the carbon offsetting and credit markets

Click on the link below to watch the 11-minute interview with Sheren.