In March 2024, Yale School of Management students had the opportunity to learn about an emerging product category at the cutting edge of sustainability and finance – carbon insurance. Social Impact Lab hosted James Kench, Head of Insurance at Kita, for a lunch-and-learn session about the opportunities and challenges present in the carbon insurance market.
As James explained, insurance is essential to unlock financing for decarbonization projects. Achieving net-zero goals requires massive investment and these investments are typically in the form of carbon credits. But without suitable insurance products to manage risks, investors are more reluctant to buy carbon credits. James illustrated the lifecycle of a carbon credit to pinpoint different risks present at different stages. For instance, at the concept stage, political and non-delivery risks are the main concern. But at the retirement stage, price, reversal, and invalidation risks become more salient. These nuances made us appreciate the need for tailored insurance products which address specific pain points in the carbon credits market.
While insurance is primarily viewed as a risk transfer tool, James emphasized the role it plays in signaling quality as well. Investors feel more confident about decarbonization projects which have an insurer’s stamp of approval because it reflects an extra layer of due diligence. As a result, higher quality projects find it easier to attract financing and incur a lower cost of capital.
The carbon credits market has different buyer personas and James took us through some ways to segment the market, from heavy emitters seeking to offset their own emissions to financial institutions aiming to resell credits. But as James noted, these segments are not clear-cut. For instance, oil and gas companies are starting to act as middlemen too.
During the discussion, James also touched upon policy issues which affect the carbon insurance market. For instance, the standards for carbon credits are evolving, increasing the risk of credits being downgraded. Further, countries face mounting pressure to meet their net-zero commitments, increasing the risk of governments refusing to export carbon credits. On the more positive side, he noted that local community engagement is emerging as a hallmark of high-quality projects.
A significant portion of the talk was dedicated to the innovations in carbon insurance. For instance, Kita pays out claims in both cash and carbon credits. The ability to pay out a claim in carbon credits helps insurers manage price risk and helps buyers meet their emissions targets. However, carbon credits are not entirely fungible. So, insurers face the complex task of devising a matching method that considers various factors including geography, project type, rating, etc.
James graciously fielded a plethora of questions from the roomful of curious students. During the Q&A session, he elaborated on how carbon insurers are building product awareness, the vital role of insurance intermediaries in niche markets, and his personal favorite type of carbon credits (mangroves and biochar!).
We walked away from the session with clear mental models of sizing, segmentation, and pricing in the carbon insurance market, as well as a practical understanding of various policy and implementation challenges that must be addressed.
