The role of insurance in protecting carbon markets from wildfire risks

California's 2024 Park Fire highlighted wildfire threats to forestry carbon removal projects, releasing carbon dioxide and reducing future carbon removal. Daniel Bannister, Gabrielle Osborne and Oliver Colman outline how comprehensive risk management, including insurance solutions, is essential to safeguard these projects.

In 2024, California experienced its hottest summer on record, with temperatures in June to August rising 5ºC above the 1895-2000 historical average, resulting in several large wildfires.

One of the most notable was the Park Fire, which burned 430,000 acres (174,000 hectares) across Butte and Tehama counties in July. Ignited by arson, the fire spread rapidly due to the unusually hot and dry conditions. The Park Fire ranks among California’s largest, reflecting a trend in recent years where four of the state’s largest wildfires have occurred in the past seven years.

Although improved detection and suppression efforts have helped stabilise the total number of wildfires across California in recent years, rising temperatures and prolonged drought continue to drive a steady increase in the total area burned. With wildfires becoming more intense, the future of forestry projects designed to capture and store carbon dioxide is increasingly at risk.

The dual threat to carbon removal projects

In 2024, wildfires – including the Park Fire – burned over 52,300 acres of California forests designated for carbon removal projects. The burning of such forests poses a dual challenge: first, wildfires release vast amounts of carbon dioxide into the atmosphere as forests burn, reversing years of carbon storage.

Second, they reduce the capacity of forests to absorb future carbon, weakening their role as natural carbon sinks. Compounding this issue, research suggests that land and ocean systems are currently absorbing far less carbon than before, highlighting the importance of understanding and protecting natural capital.

Buffer pools and their limitations

Carbon removal projects such as those in California rely on buffer pools – reserves of unsold credits meant to replace those lost to such disasters as wildfires. However, these safety nets are under significant strain due to the increasing intensity of wildfires. Over the past decade, wildfires have consumed an estimated 11 million buffer pool credits, far exceeding the 6.6 million credits reserved for wildfire losses over the 100-year lifespan of current projects.

This growing pressure on buffer pools has prompted calls for a reassessment of their size and structure. Experts recommend updating buffer pool contributions and halting the approval of new projects in high-risk wildfire regions to ensure the resilience of carbon markets.

However, buffer pools alone are not sufficient to address the growing complexity of these risks nor to protect forests and their vital role as carbon sinks. A comprehensive risk management strategy, including tailored insurance solutions, is required to safeguard carbon removal projects against escalating risks.

Carbon insurance: a growing market

As highlighted by the World Bank, robust risk management strategies are essential for maintaining market integrity and ensuring carbon markets remain effective in delivering both environmental and financial benefits. These markets are essential for accelerating climate action, providing mechanisms for organisations to meet sustainability goals.

Forestry and land-use carbon credits were valued at more than $22.5bn globally in 2023. This includes projects such as reforestation, afforestation and improved forest management, which directly relate to forestry carbon removal efforts.

With a projected compound annual growth rate of over 15.1 percent, the US is expected to be a significant contributor to this growth.

As these markets grow, the demand for insurance products tailored to safeguard carbon removal projects is expected to rise, with research estimating that the market for risk transfer related to carbon markets could be worth $10bn to $30bn of annual gross written premium by 2050.

Carbon insurance solutions are vital to ensuring that forestry carbon removal projects remain viable and resilient against escalating risks such as wildfires. By offering protection to buyers and sellers of credits alike, as well as to financial institutions lending capital, these products drive confidence in the market, unlock lending capacity and facilitate the financing of new projects. Without such protections, organisations may hesitate to invest in forestry restoration initiatives, perceiving them as too vulnerable to future disasters.

Collaboration is essential

However, safeguarding the future of carbon removal projects requires more than individual solutions. A collaborative approach – where insurers provide innovative risk transfer solutions, investors and policymakers prioritise resilience, governmental bodies establish supportive frameworks, brokers facilitate tailored coverage, researchers deliver actionable insights, and project developers implement best practices – is essential.

By aligning risk strategies with the realities of escalating climate threats, these stakeholders can help protect forestry projects from the dual risks of wildfires: the immediate release of stored carbon and the long-term loss of sequestration capacity. With the carbon dioxide growth rate rising sharply in recent years, protecting forestry carbon removal projects is essential to achieving global climate goals.

This article originally appeared in WTW’s natural catastrophe review, July-December 2024.