ANALYSIS: Insurance products address Article 6 risks, market need
Quantum Commodity Intelligence – Insurance for carbon credits is still an emerging concept, but there are now several options available to cover the diverse risks associated with this market.
With market players now planning for Article 6 – the part of the Paris Agreement regulating carbon credit transfers between countries – the importance of insurance has grown, as market risks have become more prominent.
A key concern is the risk of countries failing to grant corresponding adjustments, leading more market participants to seek solutions to manage this exposure.
Among the leading insurers in this space are Oka, Kita, and CFC. Meanwhile, Howden, an insurance broker, offers expert guidance along with its own products.
Non-standardised market
Insurance types are broadly of two kinds – coverage for non-delivery of forward credits and coverage for the risk of reversal of previously delivered credits.
While there are certain homogenous 'products' offered by the various providers in the market, the actual insurance provided to each customer differs.
"Pretty much everything is bespoke," said Thomas Kelly, senior associate, Howden Climate Risk & Resilience.
"There are policy wordings that that we and other insurance providers have developed, which are the 'base wordings'," he said. "But then there's always room to flex and to negotiate within those wordings. They're not off the shelf policies," said Kelly.
With the different kinds of projects, locations, and crediting periods, a template insurance policy might not always be possible.
"Although, I suppose, that's the goal. As the market matures, the idea is for it to become more commoditised, to make it easier for all parties involved," he said.
"Even the LoAs [letters of authorisation] we've seen are all quite different in terms of the wording within them and the rights that governments either give or don't give within those LoAs," he added.
An LoA is provided by a host country to a developer that guarantees the credits will be 'correspondingly adjusted', or deducted from those that will be used against the country's own Nationally Determined Contributions (NDCs) – Paris Agreement goals.
Kelly said some LoAs are not insurable because there is no recourse that the insurers can have.
The ambiguity around Article 6-eligible carbon credits has resulted in increased demand for insurance products with a range of providers offering different solutions to the market.
CFC includes Article 6 coverage within its non delivery policy. "CFC's policies provide coverage for Article 6 eligibility as standard, meaning if there is a problem with a letter of authorisation or corresponding adjustment (CA) associated with a project, such as a national government revoking a CA due to the pursuit of their own nationally determined contributions, CFC will pay to replace those credits on an agreed value basis whether forward or spot," said George Beattie, head of innovation at CFC.
Kita and Oka, however, have separate products to cover Article 6 associated risk.
Kita covers Article 6 risk under their 'Carbon Political Risk Cover' product. "Carbon Political Risk Cover provides protection against traditional political risk and contract frustration perils, as well as bespoke coverage for carbon delivery failure. This includes coverage for risks associated with Article 6," said Eilís O'Keefe, carbon markets and partnerships analyst at the company.
Oka's "Corresponding Adjustment Protect" product insures against the risk of Article 6 revocation, protecting the credit holder if the developer's host country fails to apply a corresponding adjustment.
"The payout provides the policyholder (ie, developer) with the necessary funds to replace the affected credits with Article 6-authorised credits," said Chris Slater, founder and chief executive of Oka The Carbon Insurance Company.
"In this way, the developer's airline customers can be assured of their compliance with the relevant regulations – avoiding litigation or financial and reputational damage – and can otherwise trust that their carbon investment has not been double claimed," he said.
Coverage
While some insurance providers focus on the buy side, others focus on the sell side. Different providers also have different focuses in terms of the kind of credits covered.
CFC covers voluntary carbon credits of all kinds. However, the insurance company prefers nature-based solutions and corresponding credits.
Kita's coverage spans a wide range of carbon credits, including nature-based and engineered solutions.
"Many of our products are agnostic to project/credit type, enabling us to provide effective risk mitigation solutions across the market," said O'Keefe.
With regards to location, the insured party must have an insurable entity in the UK, US, Canada, Singapore, Switzerland, or the EU.
Oka's focus is primarily on voluntary carbon market credits that have received an Article 6 authorised label.
"Our underwriting appetite is broad, and we have designed our product for all credit types and most countries (with the exception of sanctioned ones). We assess each project and host country on their own merits during the underwriting process," said Slater.
Both buyers and sellers can approach Oka for coverage.
"That said, we work predominantly with project developers. The Oka team has a strong legacy in embedded insurance, which is the heritage on which we have designed our carbon insurance policies," said Slater.
He added that by "wrapping" credits with insurance at the point of sale, developers can sell credits faster and at a premium, and corporates can purchase with confidence and without the "headache" of due diligence.
Howden, meanwhile, has also developed its insurance product – the Warranty and Indemnity Policy – to cover demand side risk.
"Whilst the project developer was very confident in the processes and the quality of his credits, the buyers who are sitting outside of that work that has been completed over several years, don't always have a clear picture," said Kelly.
However, with an insurance policy, a buyer can feel as confident as the developer in the outcome and integrity of the project, said Kelly.
"Applying W&I insurance to carbon credits addresses key structural issues at the heart of the VCM. The single biggest issue is lack of end-user demand," said Kelly.
Kelly added that many corporates who have bought carbon credits have been accused in the media of 'greenwashing' – i.e. buying lower quality (and hence cheaper) carbon credits enabling them to pollute as usual without the concern of reputational damage.
"By going through the W&I underwriting process, the policy can act as a governing mechanism, injecting trust and bolstering the perceived quality of credits," said Kelly.
Cash or credits
A common question from those that seek insurance is whether the claim will be paid in cash or in reimbursement credits.
Kita gives clients the flexibility to have claims paid in cash or in replacement carbon credits.
"For replacement carbon credits, we work with our Carbon Credit Supplier Pool to provide like-for-like carbon credits," said O'Keefe.
In the event of a claim, Oka's policy pays out in cash that can be redeemed against replacement credits.
Under 'Corresponding Adjustment Protect', each carbon credit has a replacement value provided by the insured to Oka. "The policy pays out the replacement value per credit multiplied by the number of insured credits, less a retention," said Slater.
"The insured can update this replacement value during the life of the policy to ensure that the payout will be sufficient to cover the cost of a replacement credit, should market prices have moved," added Slater.
CFC strictly settles insurance claims under its policies in cash. "CFC's view is that in a market characterised by low fungibility and short supply of quality credits, the idea that an insurer is better placed than the policyholder to replace a credit that has been affected with an 'equivalent unit' is unrealistic," said Beattie.