EIOPA recently published a discussion paper on the prudential treatment of sustainability risks (link below) and held its sustainable finance conference on 7 December 2022.
Both the discussion paper and the conference emphasise once again the "double materiality" of climate change risks to insurers, i.e. the risks insurers' activities pose to the environment and society and the risks insurers face as a result of climate change. EIOPA acknowledges that the risk-based analysis of the influence of sustainability risks on prudential risks is complex and challenging, particularly due to the inconsistent and developing definitions around ESG-related objectives and factors.
The EIOPA paper and conference focused on 3 key areas:
- Asset and transition risk exposures - insurers investment activities may be exposed to transition risk if there is a "rush for the exit" if investors quickly move away from sectors with substantial greenhouse gas emission levels. Assets with low GHG emission levels may also be exposed to transition risk, as more climate-friendly technologies emerge as a result of climate change mitigation. EIOPA is starting to assess the potential for a dedicated treatment of transition risk exposures in solvency capital requirements, particularly for stocks, bonds and property.
- Underwriting risk and climate change adaptation - as climate change is expected to substantially increase the physical underwriting risk exposures in certain non-life insurance business lines (e.g. property, content and business interruption insurance) over time, premium levels are expected to increase substantially, which could impair affordability and availability of insurance against climate-related hazards (such as flooding and wildfires). However, adaptation measures implemented by policyholders could reduce the risk exposure and associated insured losses. EIOPA is considering a dedicated prudential treatment of climate-related adaptation measures on non-life underwriting risks in the Solvency II standard formula.
- Social risks and objectives - risks associated with socially harmful activities could result in direct financial losses to insurers, either regarding their underwriting or investment activities (leaving aside reputational risks). Quantitative evidence is needed to form risk-based assessments of the impact of social risk factors, but such evidence is currently lacking. This is due to the difficulty in defining and measuring objectively the 'social' element of ESG issues. Progress is being made, for example under the Sustainable Finance Disclosures Regulation, but at this stage EIOPA is focused on outlining the prudential treatment of social risks from a Pillar II and Pillar III perspective, as part of the amended Solvency II delegated regulations.
Some of the key themes apparent from the discussion paper and the conference are:
- the risk that increasingly frequent and severe natural catastrophes driven by climate change (such as flooding and wildfires) will increase the protection gap, as insurers may raise premiums to unaffordable levels or exclude/decline cover;
- the need not just for climate change mitigation, but also adaptation, to reduce insured losses through preventative measures. Some adaptation measures can be taken by policyholders themselves but others will require public-private cooperation (such as construction of flood barriers) to support insurability and reduce the protection gap;
- lack of availability of high quality data on climate risks at a reasonable cost (although this is improving);
- no one has all the answers at present - as the fight against climate change and its consequences continues, prudential regulation of associated risks will require cooperation between the insurance industry, national competent authorities and EIOPA; and
- climate change impacts occur irrespective of national borders, so the role of EIOPA in coordinating and synchronising the response of the insurance industry will be critical.
There are over 80 questions in the discussion paper and EIOPA is inviting feedback from the insurance industry on some or all of them by 5 March 2023, via an online survey (see link below).
EIOPA outlines approaches to assess the prudential treatment of insurers' sustainable assets and activities
This article contains a general summary of developments and is not a complete or definitive statement of the law. Specific legal advice should be obtained where appropriate.