EU insurance/pension supervisor EIOPA backs scenario analysis but wary of ‘green supporting factor’

Body releases ‘opinion’ on sustainable finance and Solvency II

Last month, Europe’s insurance and pension supervisor EIOPA fulfilled another of its responsibilities under the European Commission’s action plan on sustainable finance, delivering its opinion on the EU-wide insurance regulatory regime, Solvency II.

It had been asked by the Commission to give its view on sustainability, particularly climate change mitigation, within the legislation, which sets out prudential requirements for Europe’s insurers.

“We will work with others to develop scenarios based on the best scientific knowledge.”

In short, Frankfurt-based EIOPA – the European Insurance and Occupational Pensions Authority – backs the use of scenario analysis by insurers but says no to the ‘green supporting factor’, for now – overall finding the legislation, which came into force in 2016, to be largely capable of dealing with climate risks.

The importance of scenario analysis, a key component of the TCFD’s framework, is stressed in the document as the “appropriate” means for insurers to deal with the uncertainty posed by emerging sustainability risks.

No meaningful evidence, however, was found to support the preferential prudential treatment of green assets in capital requirements, the so-called ‘green supporting factor’, though EIOPA leaves it open as to whether future data might justify such treatment.

Under the current Solvency II regime, insurance companies are expected to set aside enough capital to cope with a one in 200 worst case scenario over a one year period.

EIOPA acknowledges in the opinion that the “medium to long-term impacts of climate change cannot be fully captured in Solvency II capital requirements” within the one year time horizon. But it does not recommend this be changed.

Rather it recommends, in the non-binding position, that “complementary tools” such as scenario analysis and stress testing could be used instead to “capture impacts of climate change”.

Such analysis “should be embedded” in insurers’ risk management, governance and ORSA [Own Risk and Solvency Assessment], it says.

The supervisor says that insurers may use “qualitative scenarios” as a “first step” to help them explore the range of future climate risks and their implications.

But adds that further work is needed to “define a consistent set of quantitative parameters” for use by insurers.EIOPA’s head of policy, Justin Wray, tells RI that insurers need to have more of a ‘what if’ attitude to sustainability related risks and says that this is where “scenario analysis comes in to it”.

The development of scenario analysis is one of the follow-ups identified by EIOPA’s board of supervisors, Wray says.

“We are not climate specialists, we are not going to develop our own bespoke scenarios but what we will do is work with others to develop scenarios based on the best scientific knowledge that’s out there.”

The ‘green supporting factor’, an idea that was floated by the EU’s High Level Expert Group on sustainable finance, whose work informed the Commission’s action plan, has received a fair degree of push-back.

Axa’s CIO Pascal Christory expressed his misgivings in an interview with RI in July.

And earlier this year, Matthies Verstegen, Senior Policy Advisor at PensionsEurope, the Brussels-based industry body, told RI that “we would want to see very strong evidence that [green] factors have a risk aspect before it was introduced.”

EIOPA’s own consultation document on Solvency II in June this year found that “views are split” on the topic, though there was a general sense that Solvency II, as a prudential framework, needed to “remain risk-based and avoid imposing investment incentives”.

Wray says: “We are not saying there will never be a case for the green supporting factor, what we are saying is, that having looked at the evidence, we cannot make this case at this point in time.”

Future work for EIOPA is also detailed in the document. It includes working with fellow European supervisors the European Securities and Markets Authority (ESMA) and European Banking Authority (EBA) on drafting “regulatory technical standards” on sustainability disclosures in the financial sector.

EIOPA is also currently preparing for a “sensitivity analysis exercise for climate-related risks”, which will take place next year and will build on the work it has already done with the 2 Degrees Investing Initiative (2ii) on climate scenarios.

Details of this work will be discussed in an EIOPA workshop to be held later this year.

EIOPA is also still working on its advice to the European Commission on short term pressures in financial markets inhibiting the factoring in of sustainability, a task that is also being conducted in collaboration with the EBA and ESMA.