As carbon trading gathers pace in the EU and more broadly, the question for many insurance businesses is how these fast-growing markets might impact insurance claims.
In a recent interview with Insurance Business, Louise Butcher (pictured), head of forensic accounting UK & Ireland at McLarens, offered her insights into the factors at play – and how insurers can mitigate the risks and embrace the opportunities it will bring.
Butcher noted that carbon trading is primarily governed by the EU Emissions Trading Scheme (EU ETS), which was established in 2005 and revised in 2018. It is the world’s largest mandatory cap-and-trade system, she said, operating across 30 countries.
Additionally, she said, similar systems exist in other jurisdictions like the UK, China, Mexico, New Zealand, and Kazakhstan. However, despite these efforts, projections suggest a potential shortfall in meeting emission reduction targets by 2030.
The pace of carbon trading is being fuelled by the increasing global emphasis on reducing greenhouse gas emissions. The EU ETS, and similar systems, provide mechanisms for companies to trade carbon credits, Butcher said, either within mandatory emission levels or through voluntary emissions reduction projects.
Butcher revealed that carbon trading’s impact on insurance claims – especially regarding property and business interruption – stems from the complexities surrounding the valuation and utilisation of carbon credits.
“For example,” she said, “under a business interruption policy, an insured loss causing production cessation may lead to reduced carbon emissions, resulting in potential savings. Unused carbon credits could be banked or sold, forming part of a mitigation strategy. However, assessing this in loss calculations poses challenges.
“Determining whether these credits are simply savings or stored for future sale, potentially after the maximum indemnity period (MIP), raises questions regarding the beneficiaries and valuation timing. The lack of specificity in policies further complicates matters, as carbon reduction valuation timing remains unspecified.”
From an insurance perspective, Butcher said, there’s several key considerations to bear in mind - including the need to understand the dynamics of carbon trading markets, to assess the implications of carbon emissions reduction on insured losses, and to establish clarity on how carbon credits are to be treated within insurance policies.
“Insurers need to consider the complexities of valuing carbon credits, addressing the lack of clarity in policy wording, and aligning coverage with insured entities’ business objectives and accounting practices,” she said. “Assessing carbon credit allocation and management on a case-by-case basis is crucial, especially for large corporations with diverse operations.
“This involves careful consideration when distributing carbon credits within the organisation or across separately insured entities to mitigate carbon footprints effectively.”
In certain scenarios, Butcher said, such as recommissioning less carbon-friendly machinery to offset turnover loss, additional costs may be incurred in acquiring carbon credits, potentially at a premium. This presents a challenge in balancing economic limits and meeting trading scheme obligations, versus mitigating losses.
“[Moreover], in the voluntary carbon market, challenges arise from incidents like biomass boiler failures, hindering energy production for carbon credit accumulation,” she said. “Acquiring additional credits incurs admissible increased costs, yet quantifying them proves problematic. Consideration of lead times in acquiring carbon-efficient machinery is essential, impacting the maximum indemnity period and raising questions about loss calculation.”
The varying accounting treatment of carbon credits underscores the importance of aligning insurance coverage with business objectives and accounting practices. Addressing these considerations at policy inception can help mitigate debate and ensure explicit agreements regarding carbon credit management in the event of a business interruption claim, Butcher said, particularly for businesses with energy-intensive operations like combined heat and power plants, or biomass facilities.
With such a range of potential implications to consider, how aware are insurance businesses of the implications of carbon trading on insurance claims? The answer varies from firm to firm, Butcher said.
She highlighted that insurers are increasingly mindful of the complexities surrounding carbon markets and their potential impact on claims related to property damage and business interruption. However, she said, further efforts may be needed to enhance understanding and develop more robust risk management strategies.
“More broadly, there’s been growing interest in the carbon trading market as an opportunity for insurers, with some commentators labelling it the next “billion dollar” prospect for the global insurance market,” she said. “In tandem, we’ve also seen the first carbon insurance policy launched to the market insuring investors in carbon projects.
“Brokers are also starting to talk about a carbon credit scheme being launched. So, it’s an area that is certainly gaining momentum.”
