Carbon credit insurance market: Challenges and opportunities in a growing sector

The carbon credit insurance market has emerged as a potentially crucial component in the global effort to mitigate climate change. 

Carbon credits are instruments that represent the reduction or removal of one metric tonne of carbon dioxide equivalent emissions. These credits can be traded on various platforms and are used by companies to compensate for their carbon emissions as well as to provide a revenue stream for projects involving new carbon removal technologies or nature based solutions that would otherwise not receive funding. The insurance of these credits is seen as a vital tool in maintaining trust and integrity in the market, as it can offer protection against the risk of non-delivery, invalid credits, and potential project failures.

This market has gained significant traction as more countries and companies commit to reducing their carbon footprints and achieving net-zero emissions.

CORSIA

In particular, the introduction in 2016 of the Carbon Offsetting and Reduction Scheme for International Aviation (CORSIA) by the UN International Civil Aviation Organisation (ICAO) provides for a global market-based measure where airlines offset emissions that exceed a set baseline by purchasing carbon credits, known as Eligible Emission Units. Whilst Phase One (which commenced in January 2024) was voluntary, mandatory compliance comes into force in 2027.

Eligibility

For the purposes of CORSIA, voluntary carbon credits are eligible, subject to approval of the issuer by the CORSIA Technical Advisory Board (TAB) and approval of the project by its host country. Any Letter of Authorisation (LoA) (issued by host countries to allow carbon credits to be traded internationally under Article 6 of the Paris Agreement) must include a requirement that a Corresponding Adjustment has been applied to the credits, to reflect that the credits have been ‘exported’ and not claimed against its Nationally Determined Contributions (NDCs). This is to prevent a ‘double claim’ scenario whereby a credit is authorised for use internationally, by virtue of Internationally Transferred Mitigation Outcomes (ITMOs) (under Article 6 of the Paris Agreement) and against its NDCs. 

Letters of Authorisation: Insurance as a guarantee

Were a host country to withdraw Article 6 authorisation or fail to apply a Corresponding Adjustment (in breach of the LoA), the relevant carbon credits would become ineligible for the purposes of the Article 6 markets and CORSIA. Any potential uncertainty regarding the legality and enforceability of an LoA and the consequential validity of the carbon credits that it is issued in respect of, can be mitigated by insurance products, leading to crediting programmes (such as Verra and Gold Standard) requiring such insurance from an approved corresponding adjustment risk insurer. This approach is designed to protect against the political risk of host countries changing their approach to Paris Agreement compliance and risks related to a breach of the LoA (and related Project Development Agreement (PDA)) between the insured and host country.

MIGA template

To tackle these LoA challenges, the Multilateral Investment Guarantee Agency (MIGA) (the World Bank’s political risk insurer) launched, in November 2024, a template to facilitate the guarantee issuance in support of private investors engaged in Article 6 carbon markets. The LoA template aims to define legal rights to carbon credits and improve the insurability of investments, by establishing an enforceable host country commitment, including compensation and dispute resolution procedures. 

Whilst providing an initial approach to standardisation of LoAs in the market, development of further frameworks for PDAs is likely to be necessary to meet the requirements of carbon credit insurers. For some carbon programme providers, e.g., Gold Standard, MIGA represents the only eligible insurer for its approved carbon credits under Phase One of CORSIA. Yet, to facilitate growth of carbon credit insurance, the market will require other insurers (including private sector entities) to be approved and provide coverage.

PDAs

For the Corresponding Adjustment risk, insurance is likely to respond where the loss arises from breach of a valid, legally binding and enforceable PDA with the relevant state entity and under the relevant laws of the host country. More particularly, market participants suggest that the PDA should include: (i) the applicable terms of the LoA, setting out the circumstances under which a breach by the host country of such LoA constitutes a breach of the PDA; (ii) governing law and dispute resolution provisions; (iii) the ability to enforce against the host country; and (iv) terms covering termination grounds. Such provisions act as the four corners of a host country agreement, providing clear and unequivocal obligations of the host country which the developer can enforce against in the event of a breach, as well as outlining any required recourse against the host country before the insurance responds. As the market develops, PDAs may need to be accompanied by legality and enforceability opinions from local counsel as a prerequisite to cover. 

Political Risk Insurance (PRI)

PRI has the capacity to cover risks unrelated to an LoA, arising, more generally, from operating carbon projects in volatile geopolitical environments (including disruption to and/or failure of project performance arising from political violence, for example). Such broad risks traditionally covered by PRI are well established, from breach of contract (where a government fails to honour contracts) and expropriation / nationalisation (where a government seizes assets or investments) to political violence / war (where political unrest or war damages assets or disrupts operations). Carbon projects affected by these risks and actions taken by host countries specifically targeting such projects, may utilise PRI cover (in addition to tailored carbon credit insurance). 

Outlook for carbon credit insurance

The recent announcement from MIGA in relation to its guarantee of Koko Networks represents a welcome advancement in the provision of insurance for carbon credits, particularly as this insurance will cover the provision of Corresponding Adjustments under Article 6 of the Paris Agreement. However, the time taken to develop and provide the coverage has been seen by some as a blockage in progressing future carbon credit insurance, with commentators questioning if it is sufficiently nimble to respond to market needs swiftly enough. This is, in part, in response to the required detailed due diligence process, which can prevent carbon credit insurance from being able to respond to carbon market issuance, transfer and sales cycles.

The carbon credit insurance market has a potentially critical role in supporting the global transition to a low-carbon economy. While the market faces significant challenges, the opportunities for growth and innovation are substantial. By addressing issues related to LoA / PDA legality and enforceability, market standardisation, and political risks in respect of carbon projects, the market can continue to develop and provide essential support for climate mitigation efforts. As the world moves towards greater environmental responsibility and pivots to assigning a higher value to natural capital and decarbonising technology, the importance of a robust and reliable carbon credit insurance market cannot be overstated.