Gallagher Re has teamed up with Nature Broking, a specialist carbon-offset portfolio manager, to work on insurance solutions for this developing market. In this interview, Richard Rudden, Head of Green Solutions at Gallagher Re, discusses the partnership and the future of the carbon markets with Luke Baldwin, CEO and Co-Founder of Nature Broking.
Nature Broking, founded in 2023, builds bespoke portfolios of carbon offsets for emitting companies. Its clients include menswear retailer Charles Tyrwhitt and Devon County Council.
Now, with Gallagher Re, it is exploring ways of purchasing insurance for those credits, covering the risks of things like carbon offset projects not working as intended; failing to secure necessary finance; or being hamstrung by regulatory changes. For Gallagher Re's clients, the partnership offers the prospect of insuring a portfolio of credits that comes pre-diversified across a range of Nature Broking's projects, rather than having to seek out such diversification in the open market.
Q: The global carbon credit market has been estimated at around USD950 billion in 2023, and is expected to grow in future years1.Can we begin by giving an overview of your expectations for the market?
Luke Baldwin: We're going through a real professionalization of the market. There have been some reputationally damaging events in the recent past, with carbon credit projects that have been poorly governed. So, the market is transitioning away from what we might call the 'nice-to-have' conception of carbon reduction – where a company purchases credits and then gets a certificate and uses that for marketing.
I'm not actually saying that's a bad thing, it's just with the intersection of policy and regulation that is coming forward at the moment, we are moving from companies saying 'I'm doing this because it's the right thing to do', towards companies saying 'I'm doing this because it needs to be done'. I'm talking about things like the EU Corporate Sustainability Reporting Directive (EU CSRD) or the Corporate Sustainability Due Diligence Directive (EU CSDDD), and the manifesto commitment of the UK's new Labour government that the top 100 companies in the country will have to publish credible net zero plans, for example.
Some businesses are starting to jump before they are pushed. Some will wait to be pushed. But whether it needs to be done today or in five years' time, at some point, they will have to do it.
Q: What's the current picture on supply, demand and pricing of carbon credits?
Richard Rudden: Right now, we're in a situation of oversupply for the current demand. That's not to say there's enough credits out there (for what will ultimately be required given governments' emission reduction targets). There's not, but there's an oversupply of current demand.
As demand increases, which we expect to happen significantly from 2025 onwards, we're looking at obviously a very big increase in the number of credits that are going to be required that will drive up prices.
So it's prudent for emitting companies to think they may have to buy more credits at some point in the near future, and to prepare for that — not necessarily by purchasing credits today, but by exploring options for future delivery.
Q: Can you also give an overview of the main varieties of carbon offset projects, and how they differ from a risk perspective?
LB: Within the carbon market, you have three key areas. First, there are 'avoidance credits'. This is someone saying 'I won't chop this tree down'. One credit represents one tonne of CO2 (or equivalent) emissions avoided. Most credits sold today come from these types of projects. The main issue is they don't reduce the greenhouse gases already in the atmosphere, and they can therefore sometimes be described as 'greenwashing'. In our portfolios at Nature Broking, we tend to steer clear of avoidance credits.
Secondly, there are 'reduction credits', which is where someone has made an active decision to stop doing something. So, they have, for example, reforested or restored an area of land so that it stops emitting CO2. Finally, there are 'removal credits', which is where someone actively removes carbon from the atmosphere and stores it as permanently as possible, either in the ground, or in several other different ways. We regard reduction and removal credits as the best kind of credits, as they have the most impact and avoid reputational risk for companies.
Q: How does Nature Broking's portfolio break down between the various CO2 reduction solutions and technologies?
LB: Each bespoke portfolio that we create for a client will be different, and depend on their appetite for risk and their attitude to innovation. We are building a big one at the moment, which is essentially majority UK-nature based solutions, so primarily afforestation and agroforestry. But the client also wants some exposure to international credits as well, so we have some overseas projects in there too. And then we have some exposure to 'new' solutions [such as direct air capture or enhanced rock weathering2], but it's not large, maybe 3% or 4% of the overall portfolio. The risks there are higher because the technology is relatively nascent.
Q: What are the typical risks and loss events that a portfolio of carbon credits can face?
LB: One of the biggest risks is business insolvency. So, in the case of direct air capture technology, for example, which is very new, the capital requirements are massive and the price of the product that gets created is very high. So, the loss event can be, does the company doing the capture actually have enough cash, and if we are buying credits forward until say 2030, are we absolutely guaranteed that the company will still be there?
If we look at nature-based solutions, you've obviously got big natural catastrophe risks. This can be tricky with large forestry estates — Canadian forestry for example. There was a big fire there last year that wiped out hundreds of thousands, if not millions of credits. For a company that has bought those credits, that's a total loss.
The final type of risk is what we might call 'Article 6' risks, after Article 6 of the Paris Agreement that creates the nationally-determined contributions to emissions reductions. There is a challenge associated with that, which is that it's possible for governments to co-opt credits that have been previously placed on a voluntary market and pull them into a governmental market. So, you might just suddenly lose out on your investment there as well.
RR: There are three key buckets. One is under-delivery of emissions reductions, and that is usually caused by risks we know about pretty well in the insurance world. It can be anything from natural catastrophes through to political risk, as Luke said. This is stuff we have been underwriting and broking for a very long time in our market.
But the invalidation risk is slightly new, arising from how you account for carbon credits under Article 6 of the COP agreement.
And then you've also got things like price fluctuation risk, and that's more of a derivative type of risk, but again, that's something that derivative markets and insurance markets know about. So, a lot of the perils, we already know how to underwrite them — it's just packaging them up into a product that fits for carbon credits specifically.
Q: That brings us nicely on to the ways in which Gallagher Re and Nature Broking are working together. Can you talk a little bit about what you're exploring?
LB: So, when I spent my time in insurance, it was all about managing the aggregate exposures. A lot of work that insurers do is about ensuring that their capital is allocated to different programs, classes of business, and geographies to keep the risk spread relatively low.
Now, in the carbon market, which is a very nascent market, what's tended to happen so far is that emitters tend to buy their credits from a single project. But if they are looking to purchase credits into the future, say to meet a 2030 net-zero target, purchasing from just one project is inherently very risky.
So, at Nature Broking, we diversify this in a very similar way to how insurance does this. We spread our clients' portfolios of credits across the multiple different types of carbon credit, and geographically as well. We ensure projects are not linked, so our clients are not overexposed.
So, understanding those risks associated with each portfolio is really important, and one element of the conversation we are having with Gallagher Re is how can we build these portfolios in an insurance type way, using kind of the skills and capabilities we have, but also the risk and analytics expertise from Gallagher.
RR: So, Luke's clients are the companies wanting to manage and offset CO2 emissions, for example Charles Tyrwhitt. They want a portfolio of carbon credits with diversified risk, which they can use to offset over the next five, 10, 15 years.
What we're thinking about here as Gallagher Re is that the underlying projects are all the same, i.e. Nature Broking has a set of projects they make available to each company's portfolio of credits. It's sort of like going into a pick and mix shop. You've got all of the sweets there, but there's a finite number of sweets that you can choose from, and what your bag looks like at the end is up to you.
So, rather than insure each individual company's portfolio of credits, if you've got the same underlying projects, then it makes perfect sense to try and create an insurance solution that sits across all of them. We are thinking about a sort of captive structure, in other words.
Usually, you would expect the individual buyers of credits — the emitting companies – to take out any insurance on those. They might come to speak to James Bosley's team at Gallagher Specialty, for example, to insure against the risk of under-delivery on a specific carbon offset project.
And that's pretty straightforward. But what we're saying here is there's a set of multiple underlying projects, so we're trying as Gallagher Re to find a 'one stop shop' solution so that Luke and his company don't need to find individual insurance solutions for each of their clients.
Ultimately, there's always going to be an appetite for insurance in this space because it gives people the confidence their investment is protected. But a captive structure offers the prospect of greater capital efficiency and therefore the product should be cheaper for each of the ultimate insureds [the emitting companies]. So, it is an interesting proposal, but we are at the point of exploring this in detail.
LB: I liken it to early days of pharmacy insurance and why Bermuda is the capital of captives, because nobody would underwrite the kind of risk that was coming out of the pharmaceuticals. Similarly, we are in the early days of carbon market insurance.
We need those loss events to give us a real understanding of how insurance should be priced in this market. We're shooting at an ever-expanding market. Morgan Stanley has estimated that the voluntary market [i.e. the part that does not include compulsory schemes like the EU's Emissions Trading Scheme] is worth about USD2 billion today, but could be worth up to USD100 billion by 2030.3
We are also speaking to our technical experts about the possibility of writing Insurance-Linked Securities off the back of this market, to allow insurers or other investors to get exposure without writing day-to-day in this line of business.
RR: The idea would be that reinsurance plays quite a big role early on, as it does with lots of captives in the early stages — just because the capital requirements are such that you need to kind of de-risk as much as you can and capitalize it over time. You can move that reinsurance lever up or down however you see fit.
But I would stress that we're not trying to overcomplicate this or walk before we can run; ultimately the carbon insurance market is still embryonic. But if we were able to create something that offered a carbon credit insurance solution to Luke's clients for a significant discount compared to the rates available for an individual policy, then that could be compelling.
Q: Richard, you've only been with Gallagher Re for about six months and it's obvious you've hit the ground running with your new Green Solutions group. Presumably, we can expect much more to come.
Yes, it's taken a little while for us to sort of shape our thinking on this, but the conclusion we have drawn is this: Insurance solutions for decarbonization and the energy transition are going to cut across all product lines. This doesn't belong in any one place.
Our view is the industry needs to do more on training, educating, upskilling and adding to the workforce where needed, but it's not going to cause wholesale shifts in teams or products. Ultimately it's about understanding new products and technologies that are coming to market, but a lot of those have an existing insurance solution available.
There are some carbon credits which are extremely niche and don't have a natural home, and those sit within our Green Solutions team to broke or to assist. We obviously talk to other broking teams around the company all the time, as well as Gallagher Re's climate and analytics teams. And of course, we talk to Gallagher Specialty's climate strategy and carbon insurance team, led by James Bosley, to make sure we are all joined-up.
Further, we are also talking a lot with our clients and partners in both insurance and reinsurance, around the education piece. We've started to engage with insurers to say, actually, here's where we would focus our time in the short term, the medium term, and further off, and so this is how you might navigate the next few years to 2030.
Ultimately, our message is simple: insuring the green transition might seem like a formidable challenge, but it's not anywhere near as scary as it might appear. And if you look at the speed of investment coming into this space, it's also a huge opportunity.
