Gallagher Re has teamed up with Nature Broking, a specialist carbon-offset portfolio manager, to work on alternative (re)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 credits for organizations looking to responsibly offset their hard-to-abate emissions. Its clients include menswear retailer Charles Tyrwhitt and Devon County Council.
Now, with Gallagher Re, it is exploring various ways of using (re)insurance and structured solutions for those credits, covering the risks of carbon offset projects not working as intended; failing to deliver or under deliver pre-sold credits; or reversal events rendering retired credits null and void. For Gallagher Re's clients, the partnership offers the prospect of (re)insuring a portfolio of credits that comes pre-diversified across a range of Nature Broking's projects, rather than having to seek out and shape such diversification from the open market.
Q: The global carbon credit market has been estimated at around USD950 billion in 2023,1 with most of that accounted for by the EU's compulsory emissions trading scheme. But the voluntary market is expected to grow fast in future years, potentially up to USD100 billion.2 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 to the carbon markets in the recent past, due to projects that had poor governance with low-integrity standards.
Now, 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 upcoming policy 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, coupled with the Prime Minister's recent pledge that the UK will cut emissions 81% by 2035.
Some businesses are starting to jump before they are pushed. Some will wait to be pushed. But whether it's today or in five years' time, at some point, they will have to purchase carbon removals to get to net zero.
Q: What's the current picture on supply, demand and pricing of carbon credits?
Richard Rudden: Right now, we're in a situation of decent supply levels for the current demand. That's not to say there's enough credits out there for projected demand over the coming years, but there's an oversupply of current demand.
As demand increases, which we expect to happen significantly from 2025 onwards, driven in part by looming near-term net zero targets, a lack of increased supply will drive prices up.
So, it's prudent for emitting companies that will have to buy credits at some point in the near future, to prepare for that — not necessarily by purchasing credits today, but by exploring options for future delivery, and building portfolios to ensure supply at the right price.
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.' Carbon avoidance credits are based on the emissions that might have existed had a project not been funded. An example is avoiding deforestation; this would have resulted in the release of carbon into the atmosphere, and so a project that maintains the forest is sold as a credit. The main issue is they don't reduce the greenhouse gases already in the atmosphere. 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, for example, when we restore degrading peat, this prevents the carbon from being emitted into the atmosphere and by stopping this, it can be used as a carbon offset.
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 most impactful credits, and net zero standards such as SBTI require removals to be utilized.
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 depends on their business identity (i.e., which carbon offsets are most impactful for their business); their appetite for risk and their attitude to innovation. One example we are working on at the moment has a majority of UK-nature based solutions, with some international projects from primarily afforestation and agroforestry. Because the client also wanted exposure to innovative and emerging solutions, we utilized some technology-based solutions such as green concrete and enhanced rock weathering, 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 large 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 capital, 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 projects – Canadian forestry for example, where wildfires have destroyed large projects. For a company that has bought those credits, that's a total loss.
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 risks, 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 or a small number of them. 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 to loss events, and then utilize insurance to add additional protection.
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 potentially the risk and analytics expertise from Gallagher.
Ultimately, however, we are working closely with Richard to explore the 'art of the possible'. We are still in the early days of insurance for the carbon markets, and there are some phenomenal solutions already developed, so our focus is on achievable goals and practical solutions.
RR: Yes, 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. Working with Nature Broking is particularly interesting because it comes from a different angle, focusing on insurance for the intermediary not the underlying buyer.
Luke's clients are the companies wanting to manage and offset their residual CO2 emissions. 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.
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 would come to speak to James Bosley's excellent team at Gallagher Specialty, for example, to insure against the risk of under-delivery on a specific carbon offset project, amongst other things.
But here 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 wouldn't need to find individual insurance solutions for each of their clients. This would complement existing insurance products on the market.
Nature Broking is an attractive partner for risk carriers because it does extensive and granular due diligence on all its projects.
Ultimately, there's always going to be an appetite for insurance in this space because it gives buyers the confidence their investment is protected. A captive structure offers the prospect of greater capital efficiency for multiple clients protecting the same risks and therefore the product should be cheaper for each of the ultimate insureds. So, it is an interesting proposal, but we are investigating whether this is plausible.
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. We would also need to work with our colleagues in Specialty, who are extremely good at crafting the insurance protections required for reinsurance.
LB: There are some amazing innovations in the insurance market, such as captives, that I would love to explore. Things like 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. Insurance has so many innovative opportunities when it comes to the carbon markets.
Insurance is critical for unlocking and scaling the voluntary carbon market but these are early days as Richard says. I think it's critical for the future that we explore different types of insurance, and the mechanisms for it, and this represents a significant opportunity for Gallagher Re and Nature Broking.
One of the things we are missing is those loss events, to give us a real understanding of how insurance should be priced in this market. But we are shooting at an ever-expanding target. 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
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, as well as Green Solutions associated with the energy transition and a global push for decarbonization and sustainability. The conclusion we have drawn is this: insurance solutions 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, if and where needed, but it doesn't need 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 (re)insurance home.
There are some, like carbon credits which are extremely niche and perhaps don't fit into one product offering, and those sit within our Green Solutions team to broke and service. 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: (Re)insuring the green transition might seem like a formidable challenge, but it doesn't need to be anywhere near as scary as it might appear from a protection point of view. The pace of investment coming into this space makes it feel a little daunting but there is no doubt it is also a huge opportunity.
