When a Carbon Credit Fails: What Brokers Should Know About Carbon Insurance

A credit is a promise, not an asset

When a company buys a carbon credit, it is not buying a tonne of carbon. It is buying a claim that a tonne was removed or avoided, and that it will stay removed. That claim rests on a project that has to keep performing for decades, a methodology that has to hold up, and a registry that has to keep the credit on its books.

Any of those three can fail. That is the whole basis for carbon insurance, and it is why the product exists at all.

Two ways a credit goes bad

The market has settled on two broad failure modes, and they behave very differently from an underwriting perspective.

• Reversal. The carbon comes back out. Wildfire, flood, drought, pest and disease, storm damage, illegal logging. The project did what it said it would do, and then nature or a third party undid it.
• Invalidation. The tonne was never really there, or cannot be proven. Fraud or misrepresentation, double counting, defective ownership of the credit, non-compliance with the methodology, monitoring gaps, failed verification. Here the loss is a paperwork event, but the credit is just as gone.

Reversal is a catastrophe exposure. Invalidation is closer to a professional liability or financial lines exposure. Most brokers will recognize the second one faster than the first.

Buffer pools were never built for this

Registries have long held back a share of credits in a buffer pool, roughly 10 to 20 percent depending on the registry and the project's risk rating, to be cancelled if a reversal happens. It works for routine losses. It was not designed for correlated catastrophe.

Recent analysis of the California forest buffer pool found that a single large fire season can erode a meaningful share of the entire reserve, and that the pool may be several times short of what long-term reversal risk actually requires. A shared reserve that runs out is not much comfort to the buyer holding a cancelled credit.

Where the coverage sits today

Specialist carriers now write reversal and invalidation cover, typically on a three year term from issuance, triggered when a registry removes, cancels or invalidates the insured credit and the holder has no recourse under a developer contract. Settlement is in cash at stated value so the holder can go buy replacement credits. Cover is increasingly embedded at point of sale by the developer or exchange rather than bought after the fact by the end user.

Why this matters in Canada

Federal money is moving into restoration and nature-based projects, and Canadian developers are generating credits that Canadian companies are buying against public net-zero commitments. The projects sit in a country with a wildfire profile that makes reversal a live concern, not a theoretical one. Domestic insurance capacity for this risk is effectively absent.

If you have a client buying, selling, or lending against carbon credits, the questions are simple. Who holds the credit if it is cancelled? What does the purchase agreement actually promise? And is anyone in the chain insured for it?

TerrAssure Underwriting Solutions is tracking this market as it develops in Canada. If a client of yours is exposed to it, we would like to hear about it: info@terrassure.ca.