Insurance stakeholders have been invited to comment on the potential for a dedicated prudential treatment of sustainability risks within the EU.
Such a mechanism opens the door for supervisors to reduce minimum capital requirements – which are set aside by insurers to mitigate potential losses – if a project is deemed as having less climate risk and vice versa. Supporters of this regime argue that green projects are inherently less risky than polluting ones and that such a policy would incentivise insurers to take on more sustainable projects.
A discussion paper by the European Insurance and Occupational Pensions Authority (EIOPA) yesterday suggested that adaptation measures by insurers could “lower the frequency and intensity of climate-related losses”, and therefore benefit from such an intervention.
“In that regard, the risk of mispricing insurance policies due to climate change might be reduced and underwriting pools with and without climate-related adaptation measures might show significantly different underwriting profiles,” EIOPA said.
Examples of adaptation measures cited by the regulator include building improvements to combat flood risk like water-resistant walls, irrigation of crop fields against drought risk and heat waves, and weather forecasting and warning systems.
The regulator announced a pilot data collection on the topic earlier this year, which will complement stakeholder responses to the discussion paper.
EIOPA has also asked for feedback on how the transition to a less carbon-intensive economy could potentially impact prudential risks related to portfolio investments in stocks, bonds and real estate.
Finally, EIOPA is assessing how social risks could impact prudential supervision but only in relation to disclosure and institution-specific capital requirements which it sets directly. Pillar 1 capital, which is held against core risks and makes up the bulk of an institution’s capital buffers, is excluded.
The regulator said that social factors could cause direct underwriting risks to insurers due to operational and liability risks, and indirect reputational risk.
The discussion paper is the first step towards a final research report on a dedicated prudential treatment addressing environmental or social objectives by EIOPA. It has been requested to do so by the EU executive under an ongoing review of the EU’s supervisory framework for the insurance sector, known as Solvency II.
The regulator said that it intends “to consult publicly on empirical findings and potential policy implications” at a later stage. The comment period ends in March 2023.
EIOPA’s banking equivalent, the European Banking Authority, poured cold water on the proposed policy measure in an interim analysis earlier this year. It is due to deliver a final report by 2023.