Protecting carbon credits

Lloyd’s insurer Kiln has underwritten the first insurance product designed to cover carbon credit eligibility risk.

The policy, developed by the insurer’s enterprise risks team with specialist coverholder Parhelion and written on behalf of a major international bank, is designed to provide more certainty and stability to financial institutions trading carbon credits in Europe.

The risk that a change in legislation by the European Union could render carbon credits, or Certified Emission Reductions (CERs), suddenly worthless is one of the factors holding back the market. “Policy uncertainty is one of the main barriers to investment in carbon emissions reductions. By reducing the policy risk, an innovative insurance product of this kind will give confidence to the buyers of CERs and support projects that are critical to the fight against climate change,” says Alice Chapple of sustainable development organisation Forum for the Future.

CER credits are financial assets which can be generated when companies remove harmful greenhouse gasses from the environment by adopting “greener” practices. Developed under the Kyoto Protocol, countries can buy credits to offset their own emissions helping them meet carbon reduction targets. Banks can purchase “options” to buy the credits at a fixed price, which can then be traded at a later date when the price goes up.

Insuring against policy risk should bring greater liquidity to the market, thinks Paul Culham, active underwriter at Kiln. “What we’ve done is used fairly conventional insurance products but applied it to a completely new area of industry,” explains Culham. “We saw it as a very nice way of combining the skills we’ve got on the credit and political risk arena with the skills we’ve got in the green energy type of arena and combining the two areas.”

He expects to see demand from other financial institutions involved in carbon trading. “The banks and traders will take the commercial risk – the price risk and the movement in the actual underlying pricing risk,” he explains. “The risk they’re passing on to us is that the entire system becomes null and void because the European Union decides to change the law – so we’re giving them the stability that the environment in which they’ll want to trade these things will still exist.”

Ripe for innovation
 
The insurance industry’s role in supporting green industries has taken off in recent years with a number of Lloyd’s companies developing dedicated renewable energy teams to design cover for some of the unique risks faced by the sector.

This includes exposures related to large renewable energy projects such as offshore windfarms as well as developing technologies such as photovoltaic (PV) cells used to harness solar energy.

As with any new industry the use of relatively new and untested technologies can prove to be a barrier to investment. This is where insurance products, developed in partnership with industry specialists, can help provide a backstop allowing the market to flourish.

German reinsurer Munich Re has designed a number of products for the wind and solar thermal industries. In April, it launched a product in partnership with industrial insurance broker Filhet-Allard, manufacturer Solairedirect and one of its specialty primary insurers to cover long-term performance technology risk.

The insurance cover was developed after an in-depth review of the manufacturer’s processes. “With our expertise, we can assume very special renewable energy risks and thus help provide greater investment security,” said Munich Re board member Thomas Blunck.

2010 was a record for investment in the renewable energy sector where over $200bn was channelled into clean energy and related industries worldwide. The forecast for 2011 is for total investment to exceed $240bn.

“Clearly it is an expanding industry and therefore the insurance market needs to be able to adapt what we’re doing anyway and apply it to the actual need of the new industries as they develop,” says Culham.

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