Navigating risks in the VCM: How insurance powers the carbon credit ecosystem

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Photo: Unsplash

“It just makes sense that we share risk for low probability high impact events.” ― Hendrith Vanlon Smith Jr.

In recent years, the intersection of insurance and the Voluntary Carbon Market (VCM) has gained substantial attention due to the escalating focus on corporate sustainability and climate change mitigation. Yet, the evolution is still slow and without viable insurance solutions, it will be difficult to temper risks associated with carbon projects and their financial outcomes. This may cause projects to fail even before they are started issuing carbon credits.

The VCM is a complex market which aims at reducing greenhouse gas emissions or removing carbon dioxide from the atmosphere through carbon projects. Despite its noble goal, this market is not devoid of risks and uncertainties, necessitating insurance solutions. Since project developments usually require the involvement of a very diverse stakeholder base who act in a global and fragmented regulatory landscape with very long lead times and transaction maturities, they are exposed to many challenges and risks. In addition, a lack of historical data poses challenges to underwriting policies effectively. This, in turn, prompts insurers to rely on innovative risk modelling techniques and collaborations with industry experts to enhance risk assessment methodologies.

Carbon credit insurance provides coverage against various risks encountered throughout the lifecycle of a carbon project. After the design and registration phases, which may be the least risky steps in the cycle, the probably most critical stages are the development phase and the verification process. Insurance can play a significant role in reducing financial losses arising from invalidation or reduction in the value of carbon credits. This could be caused by issues such as project failure due various natural risks, the project developer’s default, regulatory changes or inadequate measurement and verification. Furthermore, it safeguards investors and project developers against the underperformance of carbon projects, ensuring they meet predetermined targets. If the project fails to deliver the expected credits due to technical issues or other unforeseen circumstances, this insurance compensates for the resulting (financial) shortfall.

The evolving nature of environmental regulations and policies poses a considerable challenge in the VCM. Insurance providers such as KITA, AxaClimate or Oka are continuously innovating to offer solutions that adapt to changing regulatory landscapes. In addition, the Multilateral Investment Guarantee Agency (MIGA), which is part of the World Bank, is working on plans to protect carbon projects against political risks in developing countries. All companies work closely with project developers and investors to identify and ease risks associated with evolving compliance standards and ensure adequate coverage against regulatory changes.

Nevertheless, despite the existence of insurance solutions, the VCM faces certain limitations. Quantifying and pricing risks accurately remains a challenge due to the unique nature of carbon projects and uncertainties associated with future policy and regulatory changes, such as further developments and restrictions on “compensation” claims or uncertainty around “corresponding adjustments”. Furthermore, the relatively nascent stage of the VCM has led to a limited pool of data for insurers to assess risks accurately. As a result, insurance providers can face difficulties in offering comprehensive coverage at affordable premiums.

In conclusion, insurance solutions play a pivotal role in mitigating risks and fostering growth in the VCM. While various insurance products cater to different aspects of this market, challenges persist in accurately quantifying risks, adapting to regulatory changes and establishing a robust underwriting framework. Continuous collaboration between insurance providers, industry stakeholders and policymakers is crucial to address these challenges and ensure the sustainability and resilience of insurance solutions within the evolving carbon credit landscape. Most important, in our opinion, will be the contribution of transparent data from all market participants, which will allow insurance companies to build their products. 

The Callirius Carbon Removal Fund provides an opportunity to finance impactful, nature-based carbon projects in an early stage. Callirius works actively with insurance providers to mitigate risks associated with the fund’s carbon project portfolio. Carbon credit insurance safeguards fund investors against the underperformance of carbon projects, ensuring the expected carbon credit streams are achieved.

Join us in this journey towards a transparent, effective and inclusive Voluntary Carbon Market. Together, we can make a significant difference in mitigating climate change.

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