ECB, EIOPA mull catastrophe and green bonds to plug climate insurance gap

Investors could take on a bigger share of the risks associated with insuring against major climate disasters in Europe under policy options put forward on Monday by the European Central Bank (ECB) and the bloc’s insurance regulator.

One of the key measures being considered by the ECB and the European Insurance and Occupational Pensions Authority (EIOPA) is to deepen the market for catastrophe bonds, which could help spread catastrophe risk to a wider set of investor and lower the overall cost of coverage.

Investors in cat bonds – which are issued by re-insurers to bolster their risk-bearing capacity – benefit from low correlation with equity and credit markets, and receive income linked to the modelled expected loss from an insured event. They stand to lose all or part of the amount paid upfront in the event of a catastrophe payout.

Public authorities should consider ways to attract cat bond issuers to their jurisdictions such as by providing grants or simplifying licensing, said the ECB and EIOPA, as the current process is expensive and cumbersome.

The EU supervisory duo is also mulling the creation of a pan-European catastrophe fund which is big enough “to provide meaningful and swift support for large-scale climate disasters”. Such a fund is proposed to be invested in liquid, investment-grade bonds compliant with the EU Green Bond Standard and would require member states to take appropriate climate risk reduction measures.

The limited disaster relief funding provided by the EU, via the EU Solidarity Fund which has an annual budget of around €500 million, is unable to meet current and future climate-related catastrophe costs, they warned.

Other measures presented in the joint paper include requiring member states to disclose the potential liabilities associated with the reallocations of funds from local and national budgets in the event of a future climate catastrophe, and prudential regulations that account for the climate exposures of property used to secure lending.

The policy proposals are intended to prompt an industry-wide discussion on how to design insurance products which could better insure EU households and businesses against climate-related natural catastrophes such as floods or wildfires. Currently, only about one-quarter of all EU climate-related catastrophe losses are insured, with the figure dipping below 5 percent in some member states.

A follow-up workshop will be held to collect stakeholder feedback on 22 May.

The ECB has separately published its third assessment of climate and environmental (C&E) risk disclosures made by EU-based banks on Friday, a year before new disclosure rules come into effect.

The ECB said that banks have increased the information they publish but the quality of disclosures is still too low to meet upcoming supervisory standards.

Banks will be required to disclose two key alignment metrics from mid-next year, in addition to other C&E risks. The first is known as the Green Asset Ratio (GAR) and captures loans made to large European companies, based on capex and revenues associated with green activities, as defined by the EU taxonomy.

The second metric, the Banking Book Taxonomy Alignment Ratio (BTAR), is an assessment of the taxonomy-alignment of a bank’s broader balance sheet and is set to be disclosed on a “best effort basis”.

Reporting GAR will primarily be a box-ticking exercise, since large EU companies are required by law to disclose taxonomy-alignment, but the BTAR has proven controversial due to anticipated data shortages on global and SME clients.

EU banks will start reporting the GAR and BTAR from June 2024, based on 2023 information.