Mitigating Risk in Voluntary Carbon Markets: The Crucial Role of Carbon Insurance
Interview with: Natalia Dorfman ( CEO, Co-Founder of Kita)
Author: Ieva Blazauskaite (Marketing Lead, Ivy Protocol)
In the labyrinth of efforts aimed at combating climate change, voluntary carbon markets (VCM) offer a unique solution to provide economic incentives for carbon reduction. However, the successful scaling of these markets isn’t without its challenges, among which risk management plays a pivotal role. Here, the promising start-up Kita comes into play, leveraging insurance to manage risks and unlock potential growth for carbon projects.
Kita: Insurance as a Catalyst in Carbon Markets
Kita, the carbon insurance specialist, creates insurance products that enable more financing for scaling high-quality carbon projects.
Essentially, Kita’s role is to act as a risk transfer mechanism. Risk exists in any transaction, and it lies on the buyer, seller, or intermediary. If these parties aren’t equipped to handle the risk, that could impede the financing or liquidity, hindering the scaling of carbon projects.
As Natalia points out, risk isn’t a bad thing. It’s all about how it is handled and managed.
Insurance enables third-party risk transfer. When a risk materializes into a loss, the insurance company will pay a claim. Kita’s flagship product focuses on delivery risk, protecting buyers (or investors) that put money upfront into a carbon project against the risk of not receiving the promised carbon credits. By doing so, Kita mitigates early-stage financing risk and promotes investment in carbon projects.
Insuring Carbon Projects at Post-validation Stage
Kita currently provides insurance for projects that have passed the validation stage. In other words, the project developers must have the Project Design Document (PDD) approved by a Validation and Verification Body (VVB) but have yet to deliver carbon credits at a predetermined price by specific dates. Looking ahead, Kita aims to expand its coverage to the pre-PDD stage.
Carbon Credit Coverage: Nature-Based Solutions and Beyond
Kita’s current coverage spans nature-based solutions under a specific transaction type — forward purchase transactions. However, Kita’s vision isn’t limited to NBS. Kita plans to broaden its portfolio to include other carbon removal technologies like biochar. The pace of expansion depends on the evolution of methodologies and MRV provision, as well as client demand.
The Importance of MRV
A fundamental aspect of Kita’s model relies on third-party loss adjusters — MRV — comparable to accountancy and auditing in the fixed-income market.
When a loss occurs, this neutral party assesses the legitimacy and extent of the loss, ensuring that no conflicts of interest arise between the insurer, the client, or the carbon seller. Hence, a robust MRV framework becomes critical in ensuring the successful operation of Kita’s insurance mechanism.
“MRV is necessary to build investor confidence. Trillions of dollars of capital will need to be deployed to reach the IPCC target of 10 billion tonnes of carbon removal a year by 2050. Investors need to be able to trust that these projects are delivering real removals with validated accounting and auditing. If this can be achieved, it is the first step to building investor confidence in the carbon removal market. ”(Kita & BeZero, 2023)
The Insured: Large Companies and Investors
Kita provides insurance coverage to large companies, either as buyers who expect to receive carbon credits or investors who seek returns in the form of carbon credits. Presently, Kita can insure companies operating in the United States and the United Kingdom. Additional countries, such as Canada, are in the pipeline.
The Carbon Project Risk Landscape
The risks faced by early-stage carbon projects are vast and varied. Kita buckets these risks into four categories:
Risk Assessment
While assessing risks, Kita takes into account the different risk categories and evaluates them through the lens of an insurance policy. The assessment uses a method similar to the performance guarantee approach. In this method, the forecasted performance of the carbon project is evaluated to determine its probability of satisfactory completion.
Streamlining access to data is crucial for the assessment process. Kita currently relies on data from various sources, including public data, partnerships, proprietary data from clients, and Monitoring, Reporting, and Verification (MRV) type data.
Data Standardization
The key challenge Kita faces, like many others in the industry, revolves around data availability, quality, and consistency. As Natalia points out, it would greatly benefit Kita if there was a larger quantity of data and if that data was of higher quality and more standardized. In particular, historical claims data plays a crucial role. Having access to past claims data would allow carbon insurance to establish a track record of claim payouts, which directly influences insurance costs. It’s similar to how car insurance companies assess risk based on factors such as age, gender, location, and car type, as they have years of data to rely on. Kita aims to reach a similar level of accuracy and reliability in their assessments. But unfortunately, as an industry, we are not there yet. In the absence of historical data, the accuracy and reliability of the available data — including forecasted project performance — become even more crucial.
What is more, Natalia emphasizes the need for templated forms — similar to Project Design Documents (PDDs) — that are consistently filled with detailed and useful information. Industry experts could collaborate to structure the data and develop a standardized “risk assessment framework.” Such a template could help to streamline processes and enhance carbon insurance effectiveness.
Establishing Project Confidence
Assuming that a good project developer possesses the necessary expertise and knowledge of carbon standards, baselines, and project maintenance, their focus lies in showcasing their capabilities and demonstrating project quality to the market. Utilizing available market signals, such as rating agencies, can provide buyers with confidence and assurance in the project’s credibility. While insurance serves as a stamp of risk assessment rather than quality, it offers buyers a level of confidence. Ongoing data availability, particularly for nature-based projects, is challenging but crucial. Implementing more frequent audits, verifications, and monitoring that are trustworthy would greatly enhance the ability to demonstrate ongoing project performance. Consistency in performance opens up opportunities for various forms of financing and risk protection. However, these advancements are challenging and require the collective efforts of the evolving market.
Future Predictions for the VCM
For the future of the voluntary carbon market, Natalia envisions increased convergence with the compliance markets and possible regulatory disclosure requirements, making the VCM less voluntary. The co-founder of Kita also foresees a possible shift in the nature-based side of the market towards a focus on biodiversity and other co-benefits. Improvements in Measurement, Reporting, and Verification (MRV) practices are expected, providing greater clarity and certainty for investors. More clarity in terms of Article 6 of the Paris Agreement in the next few years might spur investment and certainty. Also, the implementation of the 10 Core Carbon Principles and the Claims Code of Practice could provide companies with more confidence in engaging with the market.
As the market evolves, project financing may increasingly rely on project bank-led approaches, which could open doors to enhanced financing opportunities.
Conclusion
Kita’s innovative approach to using insurance to manage risks in carbon projects opens up new possibilities for project financing and scalability. The integration of insurance as a risk transfer mechanism helps mitigate early-stage financing risks and promotes investment in high-quality carbon projects.
Standardization and accessibility of data remain critical for effective risk assessment. It becomes increasingly important to establish project confidence through reliable data, ongoing performance monitoring, and market signals. By addressing these challenges and embracing future developments, we can build a more resilient and impactful voluntary carbon market.
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