‘Mandatory’ insurance: Navigating Article 6 and CORSIA
It's COP29, aka the “finance COP”, and Kita is discussing how carbon insurance is helping drive finance to scale high integrity carbon markets. In this blog, we highlight how insurance can help scale Article 6 and CORSIA markets by mitigating revocation risk, and how insurance eligibility requirements being adopted by Carbon Standards can be an enabler to these efforts (and how they can avoid being a hindrance). This article is intended for Carbon Standards, Project Developers, Financiers and Regulators who seek to scale these markets.
Successful implementation of Article 6, and by extension, CORSIA – due to its use of corresponding adjustments - is expected to drive finance to high-integrity carbon projects. However, challenges remain - including the risk of government revocation.
As we outlined in our previous explainer here, to ensure alignment with the CORSIA mechanism, Standards are listing insurance as a requirement to protect against the scenario in which a Host Country either revokes its Article 6 authorisation or fails to apply a Corresponding Adjustment. The topic of revocation has been prominent during Article 6 negotiations at COP29 and we are looking forward to conclusions on this front. These risks hold back deployment of institutional finance, but fortunately insurance is well placed to mitigate these risks.
In our previous COP29 blog, we explained how insurance can be incorporated into Buffers. In this blog, we cover our work with/suggestions to Carbon Standards on how they can incorporate political risk insurance (“Carbon Political Risk Cover”) into their guidelines, to manage the risks associated with Article 6 and CORSIA.
Common questions from Standards and the wider market include:
How should Carbon Standards implement Carbon Political Risk Cover and determine eligibility requirements, so market stakeholders know which insurance policies are ‘approved’?
How can insurance comprehensively manage risk, while not causing undue burden and cost upon Project Developers?
How can Carbon Standards understand and protect themselves against potential coverage gaps?
Given the overlaps in the questions being posed to the Kita team from Carbon Standards and stakeholders across the market, this article highlights key “DOs” and “DON’Ts”. Our goal is enabling two very important things:
Faster adoption by the Carbon Standards of ‘approved’ insurance policies, to increase certainty for Project Developers and scale flows of finance towards CORSIA eligible projects.
Making sure the ‘approved’ insurance policies are palatable to the global political risk insurance market, to scale availability of these policies for market participants.
There is a balance to strike between being too prescriptive and inadvertently limiting the scale of eligible insurance, versus being too vague and as a result not having any policies eligible. Kita’s work in this space – as a dedicated carbon insurance specialist with expertise spanning the carbon markets and the political risk insurance markets – is to help strike this fine balance.
As ever, please don’t hesitate to reach out to the Kita team to discuss the below and the steps you can take to move forward.
Implementing ‘Carbon Political Risk Cover’ at Scale – THE “DOs”
We strongly believe Carbon Political Risk Cover can be widely available to protect market participants, as a strong tailwind to scaling of the market. To enable this, Carbon Standards should DO the following:
DO work with specialist insurance and legal advisors to develop insurance eligibility criteria. It is important to develop criteria that mitigate carbon specific risks, while also following generally accepted guidelines expected by the global political risk insurance market (see the DON’Ts below). Insurance, and particularly political risk insurance, is highly technical. From a legal perspective, seemingly negligible differences in wording can make a huge impact on your later liability exposure and ability to access coverage. Carbon insurance specialists like Kita understand the nuances of both carbon markets AND political risk insurance markets. Core members of Kita’s team come from an insurance-focused legal background and can provide recommendations for insurance specialist law firms who understand the carbon markets. This combination of experience can greatly speed adoption of suitable insurance solutions across the market.
DO work with specialist insurance and legal advisors for a gap analysis of your risk exposures. We currently see most Carbon Standards assigning the requirement for insurance coverage to the Project Developer. It is important for the Standards to realise this will leave them directly exposed to gaps in coverage. Examples here include insolvency or wilful negligence/fraud of the project developer, which invalidates the insurance policy; and/or instances where the Project Developer is unable to pay for expanded cover. These examples, as well as others, can leave the Carbon Standard with an outstanding liability to cover the loss themselves. It is important to understand these gaps and associated costs and liabilities they can bring, such that Carbon Standards can implement appropriate proactive solutions. The Kita team believes one such solution is a centralised insurance policy at the Carbon Standard level, which is the most cost effective and comprehensive way to mitigate risks for all market stakeholders. Please get in touch to further discuss this option, as well as wider gap analyses.
DO consider how to minimise the burden on project developers. As noted above, assigning the responsibility for insurance to project developers will leave Carbon Standards exposed to coverage gaps. There are other challenges here as well. Project developers may struggle to access these insurance policies for the following reasons: (i) They are small/new and considered high risk; (ii) They are incorporated in a country where insurance penetration is not high; (iii) They cannot afford the cost of the policy. We suggest Carbon Standards DO consider other insurance options, whether centralised insurance policies as noted above, or allowing investors to be the insured party, who often have rights to the carbon via contractual means, and who are generally more resilient to the challenges listed in i-iii.
DO focus on building insurable Letters of Authorisation (LoAs). We will focus on this more in our next article in this COP series, but it is important enough to say twice. Insurable LOAs should:
a) Constitute a legally valid, binding and enforceable agreement against the contracting entity(ies) of the host government, under the laws of the host country.
b) Contain clear governing law and dispute resolution provisions, including rights of recourse against the host government via arbitration, clearly setting out the actions required by each party to the contract and under what circumstances each can terminate the agreement.
c) The Letter should expressly authorise the use of the mitigation outcomes for the achievement of the country's NDC, for other international mitigation purposes (such as CORSIA), and/or for other purposes (such as Article 6.4), if such is their intended use. It should also express a commitment to ensure environmental integrity and to apply robust accounting. This must be substantiated with a clear definition of first transfer and a commitment to apply corresponding adjustments in the country’s accounting and reporting under Article 6.2 rules.
d) The Framework Agreement should refer directly to the LoA, and clearly outline the circumstances under which the host government’s non-compliance with its terms constitutes a material breach.
Implementing ‘Carbon Political Risk Cover’ at Scale – THE “DON’Ts”
Insurance, and particularly political risk insurance, is a technical market. Seemingly small differences to a non-market observer can significantly impact the resulting level of coverage, liabilities and outcomes. We have outlined below some missteps we are seeing across the market, with the aim of helping direct people towards the “DOs” listed above as helpful alternatives. Please note none of this is legal advice, and we DO suggest you engage with a specialist insurance law firm as noted above.
DON’T assume the project developer must be the insured party. Across the multiple Carbon Standards we have spoken with, we see most insurance requirements to-date being stated as the responsibility of the Project Developer. Assigning the responsibility for insurance to the Project Developer inherently leaves the Carbon Standard with gaps in coverage and resulting liabilities. As noted above, we DO recommend you work with carbon insurance specialists like Kita to make sure you understand what these gaps and liabilities are, and the best ways to mitigate them. While we have an existing insurance policy available to support Project Developers today (see here), we believe that as the market grows, the most comprehensive and cost-effective way to mitigate these risks for all parties is for the Carbon Standard to be insured at a central level (as we noted in our prior COP29 article on Buffers + Insurance).
DON’T underestimate your exposure to outlier risks. As noted above in the “DOs”, we suggest a gap analysis to identify key risks Carbon Standards might be exposed to, in the instance where the Project Developer is the insured party, such as:
Failure of the Project Developer to continue the insurance policy. We have spoken with multiple Carbon Standards who expressed valid concern about what happens in the instance a Project Developer either loses its insurance policy or is unable to pay for an insurance policy. This causes a challenge to the Carbon Standard in terms of potentially being required to take on this risk itself – either via needing to pay for the policy or take on an administrative burden of managing policy adherence. We are seeing Carbon Standards seek different routes to address this risk and propose either “Difference in Conditions” type policies or centralised policies for the Carbon Standard itself, as the most comprehensive and cost-effective way of managing Project Developer default. (See our “DO” in terms of doing a gap analysis with carbon insurance specialists to identify appropriate solutions).
Legal Host Country Action that causes loss. In some instances, Host Countries will be well within their legal and contractual rights to implement legislative changes, for example a tax applied fairly and evenly across all entities within that country. Insurance companies will generally not insure this type of action. Generally, what is covered within political risk insurance policies are “Discriminatory” actions of Host Countries, targeted unfairly towards either specific Project Developers and/or types of projects. The lack of cover for “non-discriminative” action will leave Carbon Standards exposed to this risk, which is another key reason for the gap analysis noted in the “DOs” above.
DON’T create insurance requirements at odds with the appetite of the global political risk insurance market. This is a key risk because if Carbon Standard’s requirements are too niche and don’t follow generally accepted insurance guidelines, the insurance industry will not support the carbon markets at scale. Key examples here include:
Level of loss covered: The expectation in the market right now seems to be that insurance companies should cover 100% of the loss. This is challenging for the insurance industry, given uncertainties around future price and supply, and the general basis of how insurance works in terms of "limits” (i.e. the maximum amount an insurance company will pay under any specified insurance policy, which will be noted in the insurance policy documentation). We instead suggest a revision in terminology to note how an insurance policy could “support” the insured in meeting its obligations, e.g. covering 90% of the loss, in the instance the insured can demonstrate its ability to cover the remaining percentage. Note: if the current requirement of 100% coverage stands, this will either lead to (i) very expensive insurance policies with required high limits; and/or (ii) increased liability on the Carbon Standards to take on payment to increase limits if the Project Developer isn’t able to afford to do so.
Loss Trigger vs Proof of Loss. In insurance parlance, a “loss trigger” is the occurrence of an incident that causes a loss. “Proof of loss” is demonstrating proof to the insurance company a loss actually occurred. For example, if you have car insurance, a ‘loss trigger’ could be another car hitting you, and your ‘proof of loss’ could be the police report. It is beneficial for insurance policies to be as specific as possible on these two things to reduce potential for disagreement at the point of paying an insurance claim. We have noted to-date (i) the loss trigger requested by Carbon Standards can be too broadly defined; and (ii) the loss trigger is getting confused with the proof of loss, in terms of when an insurance claim will be paid. Both of these points can decrease the likelihood of an insurance policy paying a claim in the instance of a dispute. Greater clarity is beneficial for everybody in the market.
The Kita team is passionate about serving as a bridge between the specialist worlds of carbon markets and insurance, increasing mutual knowledge and bringing the benefits of insurance to carbon projects. We see the incorporation of Carbon Political Risk Cover into the market as a huge opportunity to mitigate a key risk currently holding back institutional financing. Kita’s expertise in this sector, allows us to work closely with market stakeholders to address the existing “DON’Ts” in the market and move towards successful implementation, supported by our “DOs”.
Any Carbon Standard, regulatory body, project developer or financier interested in scaling the Article 6 and CORSIA markets - Please DO get in touch with the Kita team if you wish to discuss further.
Please see earlier articles written on how Insurance can be incorporated into the carbon markets in collaboration with Carbon Standards here: