The insurance industry on carbon stored in forests: “It’s a regulatory asset”

On Tuesday, 9 December 2008, I visited the Sheraton Hotel for an event titled “Making Forests Competitive: Practical solutions for permanence”. Organised by the legal firm Norton Rose, in association with the UNEP Finance Initiative and Carbon Markets and Investors Association, the event looked at the possibilities for the insurance industry to insure forest carbon.

The principle is simple. There are lots of risks associated with storing carbon in forests. If you are buying or selling carbon you want a contract and want it to be insured. While insurance cannot prevent the carbon being released to the atmosphere, it can insure against financial loss, thus making financing forest projects more attractive to investors. The point of insurance is “de-risking investment in forests”, as Phil Cottle from ForestRE put it.

Anthony Holbey, a Partner and Head of climate change and carbon finance at Norton Rose, introduced the meeting. “As lawyers, we get involved in every aspect of the carbon market,” he said. Norton Rose is getting more involved in forestry projects. “Some very clever people have developed ways of bringing finance into forests,” he said, “but the key issue is permanence.” The non-permanence of the commodity kills about 90 per cent of forest projects that Norton Rose looks at.

The UNEP Finance Initiative is a partnership between UNEP and 180 financial institutions, including banks, insurers and fund managers. Paul Clements-Hunt is head of the UNEP-FI. He explained that he is a UN official, a bureaucrat. He asked the question: “Is there a commercial insurance option to make forests work better?” Can insurance “free up” some of the carbon value in forests? “There is an option in terms of insurance in these markets,” he said.

Anna Lehmann is chair of the Carbon Markets and Investors Association’s forestry group. She spoke about “Creating permanent forestry credits”. She works with a company called Sindicatum Carbon Capital. “Forests are a dynamic ecosystem but a permanent carbon pool,” she said adding that 60 per cent of terrestrial carbon is stored in forests. “Emissions from forests are irreversible.”

She talked about carbon sequestration in commercial plantations and argued that although the carbon stored in a particular area of plantation will fluctuate when it is thinned or harvested, at the landscape level plantations work as a carbon store. “Forestry insurance already exists in this market,” she said.

She listed the risks that can be insured against, including pests, diseases, fires, changes in ownership of the land, wood and carbon (if, for example, the government nationalises the forests), and social issues (including population growth and poverty).

The private sector could help governments to resolve issues surrounding distribution of land titles or use rights by financing forest carbon projects. Clearly, she has not looked in any detail at the land rights issues surrounding Mount Elgon National Park in Uganda, where a carbon offset tree planting project by the Dutch FACE Foundation has only made things worse. Last year villagers cut down half a million of the FACE Foundation’s trees, which were planted on their farmland.

“We need to start now”, Lehmann said. Risk profiles can be used to determine the size of credit reserve buffers needed. The bigger the risk, the bigger the buffer. Insurance is not necessarily appropriate for the forest market. “There is an urgent need for pragmatic approaches,” she said. Only 15 countries own 75 per cent of the world’s forests. “That’s a comparatively small number of stakeholders.”

Phil Cottle is Managing Director with ForestRE, a company which aims to “provide intelligent capacity to forest underwriting”, according to Cottle. Set up at the beginning of 2008, ForestRE is based in London and issues Lloyd’s policies (A+ rated). “We’ll insure anything,” he said.

ForestRE is building a database of forest project related information. “There is a shortage of data, but we are collecting data day by day,” Cottle said.

He talked about the risk of fire in forests and noted that the risk is increasing. He pointed out that what we should be concerned about is not the yearly average of fires, but the risk of a catastrophe.

There are only half-a-dozen insurers who do insurance on forests and all of them will have to get involved.

He talked excitedly about the possibilities of collecting data from remote sensing. A slide illustrated how remote sensing could pin point precisely any damage to the forest, down to the removal of individual trees. A company called Eyre Consulting produces satellite data for forests. “At last insurers have the tools to monitor forests”, he said.

Juerg Fuessler, Vice President of the Emissions Unit at SwissRE, explained that his work includes hedging against fluctuations in the carbon market.

“There are many reasons that can turn a forest from a sink to a source,” he told us. His firm insures against damage by wind, fire, hail, snow, ice, pests diseases. On the “wish list” are several items such as governments not honouring contracts, a change in regulation or expropriation of forests, or migrants moving into the forest. “This is a challenge for insurance companies,” he said. Another problem is that for sinks to be permanent, forest systems need to remain intact over decades, but forest insurance contracts are usually renewed annually, although slightly longer time periods are possible, he added.

Insurance can remove many key uncertainties and can, for example, reduce the size of buffers needed. “But it’s not a silver bullet,” he said.

Charlotte Streck, Director of a consulting firm called Climate Focus and Mark Belton, Managing Director of New Zealand Permanent Forests Limited, joined the panel for questions.

Paul Clemens-Hunt of UNEP-FI said that there is a massive gap between the policy discussions and what’s happening in the market. “Why has the engagement between policy and insurers been so pitiful?” he asked.

“It’s not as if we haven’t tried,” said Charlotte Streck. She previously worked at the World Bank, including working on developing the Clean Development Mechanism. She explained that when she was at the World Bank she set up a dialogue with insurers, but the discussions did not develop very far. “This is a commodity that you can’t touch and can’t feel,” she said. “It’s a regulatory asset.”

Mark Belton explained that in New Zealand, carbon credits stored in trees are guaranteed by the government. There is no risk for the buyer at all.

He said that he’s a “sceptic” about the insurance industry and forests. In New Zealand, forest and plantation owners do not insure their timberlands. “Carbon is much more secure than timber,” he said. Even if a forest burns, if it’s not a crown fire the trees can sometimes remain standing. So the carbon remains in the forest. If the trees are blown over by the wind, the carbon remains in the tree, even though it is now horizontal. Rather than using insurance Belton said he prefers good management and management of large areas of forests and plantations.

Streck said that insurance is needed because there is anxiety relating to CDM or REDD credits. “Where are they created?” she asked. New Zealand is a pioneer. It is the only country to include forestry in its cap and trade scheme. All other schemes depend on offsets, with no government backed credit. When afforestation takes place on land that has not been forested for 10 years, that is a major land use change. REDD aims to address the drivers of deforestation but it is still very risky, she said.

Achim Steiner, Executive Director of the United Nations Environment Programme walked in near the end and gave the closing speech. “For UNEP, there has been a long tradition of working with the financial services sector,” he told us. Public policy makers realise that the level of finance required to achieve the targets is beyond the ability of governments, especially given the billions that have been effectively “mortgaged” to rescue the banks recently.

He asked the question, “What can the finance industry provide in terms of a financial platform for forests?”

A concern at UNEP, he said, was whether the technological shortcuts will materialise quickly enough. Carbon capture and storage, for example, is some way off. So UNEP is asking about the role of biosequestration. “It is a perfectly economic solution,” he said. It’s not just about emissions. He said that investing in forests could increase the “global forest estate” and therefore increase biosequestration. This could be a way of getting the private sector involved in the public governance debate. “UNEP looks for much more pro-active interventions from your sector to at least frame the issues in the policy debate,” he said.

Insurance will not help to save forests. It will not protect Indigenous Peoples’ or local communities’ rights. It will not help to prevent climate change. It will help investors, lawyers and insurers to make money. UNEP-FI, with the full support of UNEP’s Executive Director, seems to have decided that its role is to help the private sector to increase its profits.