Carbon insurance: De-risking the carbon markets

Ryan Fan: Welcome to The Sustainability Agenda, a podcast series focusing on the evolving complexities of the sustainability landscape. I’m your host, Ryan Fan. Please join me as we explore today’s most pressing issues with special guests that will give you some new perspective and help you make sense of what really matters.

Zachary Kane: I believe insurance is going to be a part of this sector going forward, as we alluded to earlier, because insurance is a pillar of every other sector, right? By no means is insurance going to be a silver bullet that is going to change the way that everyone fundamentally believes in the voluntary carbon markets. I wish it were so simple.

Ryan Fan: Welcome to our multi-part series, Profiling the Carbon Markets. The purpose of the series is to examine some of the most significant issues facing our clients in both the voluntary and compliance markets. On today’s episode, we’ll be discussing risk mitigation in the voluntary carbon markets through carbon insurance. The voluntary carbon markets have been challenged by market fragmentation and governance issues. But given the increasing recognition and demand for carbon credit use in corporate transition plans, carbon credit sellers need ways to build trust with their corporate buyers. So we’ll explore how carbon insurance can help sellers and corporate buyers allocate their carbon credit risk, the benefit of doing this and where the carbon insurance industry is headed. I’m delighted to welcome my guest for this discussion, Zachary Kane, who is Senior Vice President of Growth at Oka, The Carbon Insurance Company. Zach has extensive experience developing partnerships and engagement with some of the largest corporations in America, stemming from a diverse career that spans over a decade. Prior to joining Oka in 2023, he held senior positions with Assurity Ventures, which is the venture capital arm of Assurity Life Insurance Company, as well as with the Arbor Day Foundation, one of the largest NGOs dedicated to restoring trees and forests. He also served in the political campaigns for two US Senate candidates. Zach, welcome and thank you for joining us on today’s episode of The Sustainability Agenda.

Zachary Kane: Yeah, thank you so much. I’m excited to be here.

Ryan Fan: Yeah, look, I’ve enjoyed our frank conversations on the evolution of the carbon credit markets and I’ve been looking forward to this discussion about carbon insurance for quite some time. So let’s dive in. Zach, maybe begin by offering our audience some context on what carbon insurance really is and why it’s needed and maybe why now?

Zachary Kane: Yeah, so the easy thing about it is it’s exactly what it sounds like. We’re bringing the traditional components of insurance, simple things like trust, financial protection, risk mitigation, and just applying them to the carbon markets. Carbon credits and projects in general are subject to loss like any other asset class. What we believe is that we can never fully mitigate the risks of a forest or a facility or even honestly, the methodologies. So we need traditional risk mitigation. And typically speaking across any other asset, that’s going to be insurance. We believe that insurance is the final piece to help answer some of the questions of what if the credits underperform? What if the credits that I bought don’t do what I thought they were supposed to?

Ryan Fan: Okay, that makes a lot of sense. You mentioned financial protection benefits of carbon credit and insurance. But what about reputational protection? I read just last month, I think it was, that FedEx stated, and I’m going to quote them here because this is quite a mouthful, but I’m just going to read this out to you. Basically, they said, there is a risk that any voluntary carbon offset credits purchased, even if accepted by regulators, could be viewed by third parties as not sufficiently reflecting real, verifiable, and additional GHG reductions, leading to reputational harm. I get that companies insure other parts of their businesses and the assets, like you said. So, why wouldn’t they insure their carbon exposure?

Zachary Kane: Yeah, I mean, we agree with FedEx, right? That is a real risk that exists and companies need to be able to have confidence behind their decarbonization claims. And we’ve seen that when they don’t, it can tend to come back and bite them. What we want is to realize that not everyone has a team dedicated to carbon purchasing and outside of just a really a handful globally, most of them, this isn’t their day job. This is just one of many things they’re trying to do within the sustainability field. So what we’re trying to figure out is how can insurance play a role where we’re helping to unlock some of that discomfort around the reputational claims that they’re making. We’re not going to be able to cover for the court of public opinion, but we are going to be able to help them stand by the public claims they’re making around their carbon or decarbonization. We know that traditional underwriters can come into play here to provide a professional risk assessment. And then we use extra modeling to quantify and price the risk, just like it would if you were trying to de-risk your home or your car.

Ryan Fan: Zach, that makes a ton of sense. I guess what I want to understand is how does this unlock more demand? Some of the problems that we’ve seen is not just from a pure reputational standpoint, but a lack of education or understanding of the complexity in carbon markets. You had mentioned, there are some out there that are leading edge in terms of making their carbon credit purchases, but many are down down the learning curve. And so does this product or does this insurance offering actually help move them up the curve at all?

Zachary Kane: I mean, certainly anytime you have a third party assessment for things like quality, you’re going to have more confidence in your purchasing ability, right? Just as an example, if you’ve got a home and you find out that that home is insurable versus that home is uninsurable, that probably changes the way that you believe you’d be interested in purchasing. So just apply that then to a carbon market where you’ve got a carbon credit that ultimately is either insurable or uninsurable according to the underwriters, according to how they understand the risks of it. Are you willing to self-insure that? Are you willing to put your own capital behind if you’re wrong? Or are you needing it to be a situation where you believe, all right, there are others who have this expertise, who are looking at this on a daily basis and can ultimately take that balance sheet risk off of your books and put it onto a third party insurer. Carbon markets are evolving, right? There is a reason why insurance is newer to this market and largely because the market wasn’t large enough just yet. What we’re seeing is an increase in the market means that there’s going to be more capacity. There’s going to be more interest when you bring in traditional insurers. Ultimately, they’re going to have discomfort in something that they don’t know. And that’s where a specialization like Oka, where we can come in and say, we know carbon markets. We also know insurance and we are applying the insurance principles to this specific market.

Ryan Fan: Yeah, it’s interesting when you make that comparison to owning a home and having home insurance. The way I think about insurance and innovation, I think about things like credit default swaps, given that I come from a capital markets background. I naturally tend towards those and credit default swaps or CDSs really helped unlock the flow of capital in credit markets and allocated it efficiently, like you said, and I suspect carbon credit insurance will do the same thing. When I think about, insurance and you mentioned this just a minute ago, I think about actuaries and models built using reams of historical data. But certain carbon credit types are relatively new and I suspect difficult to model. So can you tell us a bit more about Oka, its business model, and then how you’re able to truly underwrite that risk?

Zachary Kane: Yeah, happy to. Oka is a group of insurance experts who have really built themselves on the ability to de-risk the unknown or those markets that previously were thought to be uninsurable. So we’re taking the very simple insurance principles and actuarial approaches and applying them specifically to the carbon markets and the risks that exist there. What we’re looking at are things that traditionally other people are looking at, but maybe from a different perspective. So we’re looking at additionality, we’re looking at over crediting, permanence, anthropogenic, or human induced risk, natural catastrophes, climate modeling, political risk, etc. We’re putting all of these different data points together into an underwriting engine that ultimately spits out what is the quantifiable or the priced risk that we believe that particular project has. And then we’re working to ensure that the specific risks that the clients need are going to be met. So whether or not they’re worried about those cancellations of the credits because of new data that comes out that shows, we over-credited by 20%. Or whether or not it’s something like a fire going through and burning through, which is obviously a huge reality right now as we’re constantly hearing about California or different parts of Canada that are burning and there are actual projects as we speak that are burning up and it’s just a reality. So we utilize these different data to provide a ultimate price point and we recognize there’s not lost data available, but we also have the ability to take a look at some historical data as well as the expected data from an actuarial approach which gives us other indicators. The likelihood of fire is not strictly based on what has happened in the past. We also need to look at the climate modeling and the changing climate that is happening. How are we accounting for the increase in fires because of droughts or pests and disease that are changing the paradigm of the projects themselves, not only looking backwards, but also needing to model forwards.

Ryan Fan: I’m glad I’m not an actuary trying to figure this stuff out. Does not sound easy.

Zachary Kane: I just play one on radio or TV. It’s the team behind me that is ultimately doing it. So I definitely in the same place there with you.

Ryan Fan: Yeah, good. As you and I both know very well, the voluntary carbon markets are continually evolving. So what’s new with Oka? How are you evolving?

Zachary Kane: Yeah, we’re really excited. We just launched the world’s first Article 6 coverage. So right now, Article 6 is a big topic. Specifically, the CORSIA markets are in their first phase. A lot of people are trying to quickly get letters of authorization, which are resulting in the ability to hopefully get a premium on their credits, you know, when you take a voluntary credit and you get an Article 6 label applied to it, it should be increasingly more valuable, but there’s still risks that exist within that. So what we’ve done is created a product that specifically covers for the third party guarantee that the corresponding adjustment will take place. And this is obviously getting really into the weeds of it, but corresponding adjustments are put in place to prevent double counting and that can happen because of a revocation of the LOA or a failed application. I mean, these are two items that are extremely volatile and moving, right? We don’t have corresponding adjustments that have taken place so far. We’re not sure how countries are going to handle letters of authorizations or their NDCs. So we need to have some kind of confidence and this is one of the beauties of insurance. We can try to provide further confidence in that. And that’s why we’re backing to say, all right, let’s take a look at this risk. How are we going to be able to provide a guarantee that the corresponding adjustment will take place? It’s ironic, but typically insurance says when something happens, we will pay out. In this instance, it’s actually, well, if something doesn’t happen, then there will be a claim paid. So it’s a bit of a moving target, but we believe this could create more security specifically for the CORSIA markets, because we know that there’s going to be a supply crunch right now. Depending on the estimates, it’s anywhere from 200 million credits that are going to be needed for the first phase. And right now, there’s two fuel eligible credits that are going to meet that demand. So we hope that by providing even further clarity with the insurance wrapped around these credits that not only the suppliers will feel more confident and ultimately continue to pursue additional letters of authorization, but also obviously the airlines and others that are pursuing the Article 6 credits.

Ryan Fan: Yeah, I certainly agree with you in that supply crunch coming. I can certainly see how carbon insurance can add security and assurance, especially for those that are looking to secure it from the buy side. OK, so let’s close this conversation out with a bit of a look to the future. So in terms of the future outlook, what do you see the carbon insurance industry in three years? And what impact do you see your industry having on those carbon markets?

Zachary Kane: Yeah, I mean, ultimately, I believe insurance is going to be a part of this sector going forward, as we alluded to earlier, because insurance is a pillar of every other sector, right? By no means is insurance going to be a silver bullet that is going to change the way that everyone fundamentally believes in the voluntary carbon markets. I wish it were so simple, but I don’t think it’s going to be the case. But you look to any other market and insurance is a pillar. So what we believe is that ultimately you’re going to start to see, are those projects insurable? Are they not? Buyers are going to start to ask those questions because they’re already asking those questions. It’s a lot harder to go to your buyer after you’ve sold them a credit and then they find out that, you know, another third party was unwilling to bear that risk. And I also believe that in order for this market to continue to scale, everyone talks about the increased capital that needs to be deployed, right? We need more capital deployed. There’s not enough capital deployed. Insurance can help unlock that additional capital. We can create increased liquidity. We can provide alternative options for things like buffer pools, which ultimately are holding credits that are high value that could be sold. It’s not diversifying in the way that we believe an insurance policy could in a way that protects all parties. And it’s just examples like that where I think there’s sky’s the limit. It’s an opportunity to just take these principles around insurance like they are in any other industry and ultimately help speed up the buying timelines that are notoriously long and arduous in the carbon market.

Ryan Fan: Yeah, I think carbon insurance certainly plays a role in lowering the frictions to be able to transact in the space safely. Listen, I want to thank you for your time today, Zach. I know Oka is doing some critical work to, you know, very efficiently allocate risk in the voluntary carbon market. Thank you for your time today and shedding light on the work that you’re doing. And thank you to our audience for listening

Zachary Kane: Thank you. It was a pleasure to be here. 

Ryan Fan: If you would like to learn more about how your business can navigate the carbon markets, join us for CIBC’s Carbon Summit on October 10th, 2024 in Toronto. The summit will bring together project developers, capital providers, policymakers, and corporate buyers to discuss the evolution of the carbon markets and their nexus with the energy transition. As a prelude to the Carbon Summit, CIBC will also host a session to help companies understand how carbon credits fit into the broader decarbonization plan, and how to navigate the complexities of carbon credit purchasing. To register, please contact your CIBC Relationship Manager.Please join us next time as we tackle some of sustainability’s biggest questions, providing different perspectives to help you move forward. I’m your host, Ryan Fan, and this is the sustainability agenda.

Disclaimer: The materials disclosed on this podcast are for informational purposes only and subject to our Code of Conduct as well as CIRO rules. The information and data contained herein has been obtained or derived from sources believed to be reliable, without independent verification by CIBC Capital Markets and, to the extent that such information and data is based on sources outside CIBC Capital Markets, we do not represent or warrant that any such information or data is accurate, adequate or complete. Notwithstanding anything to the contrary herein, CIBC World Markets Inc. (and/or any affiliate thereof) shall not assume any responsibility or liability of any nature in connection with any of the contents of this communication. This communication is tailored for a particular audience and accordingly, this message is intended for such specific audience only. Any dissemination, re-distribution or other use of this message or the market commentary contained herein by any recipient is unauthorized. This communication should not be construed as a research report. The services, securities and investments discussed in this report may not be available to, nor suitable for, all investors. Nothing in this communication constitutes a recommendation, offer or solicitation to buy or sell any specific investments discussed herein. Speakers on this podcast do not have any actual, implied or apparent authority to act on behalf of any issuer mentioned in this podcast. The commentary and opinions expressed herein are solely those of the individual speaker(s), except where the author expressly states them to be the opinions of CIBC World Markets Inc. The speaker(s) may provide short-term trading views or ideas on issuers, securities, commodities, currencies or other financial instruments but investors should not expect continuing analysis, views or discussion relating to those instruments discussed herein. Any information provided herein is not intended to represent an adequate basis for investors to make an informed investment decision and is subject to change without notice. CIBC Capital Markets is a trademark brand name under which Canadian Imperial Bank of Commerce (“CIBC”), its subsidiaries and affiliates provide products and services to our customers around the world. For more information about these legal entities, as well as the products and services offered by CIBC Capital Markets, please visit www.cibccm.com.