European insurers face 25% write-downs on high-carbon equity investments under disorderly transition, says regulator

Europe’s insurance and pension supervisor, EIOPA, has published its first sensitivity analysis of insurers’ exposure to climate transition risks, finding that “losses on equity investments in the high-carbon sector can be high, reaching more than 25% on average”, based on disorderly transition scenarios. 

Losses, it found, were driven by investments in fossil fuel extraction, especially oil & gas, and also by investments in the production of combustion engine cars. 

Corporate bond portfolios fared better under the shock of a disorderly transition, “reflecting the fact that profitability declines are likely to impact equity prices”, the regulator noted. Losses were largely driven by the same sectors as equities, the analysis found. 

Overall, however, EIOPA found that the impact on the balance sheet of the insurance sector by a disorderly shift to a low-carbon economy was “counter-balanced both by investments in renewable energy” and the fact that such investments constitute “a small part of the total investments of European insurers”. 

EIOPA assessed around €3.4trn in corporate bond and equity holdings of insurers (including the UK) as part of the study, of which around €539bn is in “climate policy relevant sectors”, such as coal mining, steel and cement production, vehicle production or the power sector.

EIOPA stressed that its pioneering sensitivity analysis is a “learning exercise”, which it hopes will inform future work, including stress testing. 

The “what-if” scenarios used by the regulator envisage delayed but abrupt policy action  to move the economy towards Paris alignment.

The work on mapping equity and corporate bonds to individual firms  was done in collaboration with think tank 2° Investing Initiative.  

Due to data limitations, EIOPA said it was unable to assess certain sectors that may be affected by climate policy shocks, such as agriculture and real estate.

EIOPA also noted that the report does not consider physical risks in its analysis. Diversified portfolios might provide insurers protection from transition risks, but the regulator said that the physical impacts of climate change are “potentially substantial and can impact not only the asset side, but also the liability side and even business models”. More work, it said, is needed to understand these risks in depth. 

“Overall, these findings indicate that losses on individual assets and especially high-carbon asset classes can be substantial in terms of percentage change, especially for equity holdings” the report concludes. “However, the impact on the aggregate portfolio is likely to be much smaller, because the holdings in key climate-policy relevant sectors considered here are small compared to the overall portfolio.” 

Today, EIOPA’s Chairman, Gabriel Bernardino, raised doubts about the evidential basis for altering prudential requirements based on sustainability criteria. Kicking off EIOPA’s sustainable finance roundtable this morning, he told listeners that he does not believe there is currently sufficient data to introduce the so-called ‘green-supporting’ and ‘brown-penalising’ factors – controversial tools being floated by some in a bid to alter capital requirements to encourage investment into sustainable activities and projects. 

EIOPA’s sensitivity analysis comes a week after the European Banking Authority (EBA) put out its annual Risk Assessment Report, in which it revealed that a preliminary analysis of European banks shows that more than 50% of their exposures are to corporates in sectors “potentially subject to transition risk”. 

The EBA announced its pilot sensitivity climate risk analysis as part of its 2020 sustainable finance action plan, and 29 volunteer banks across ten countries are participating. 

The regulators said it aims to publish a final report on the pilot exercise in 2021, along with findings on how ready Europe’s banks are to apply the EU’s green taxonomy – a set of common definitions on what constitutes ‘green’ business activities. 

In the report, the EBA also stressed the importance of an accompanying “standard definition of brown activities” for assessing transition risks. 

Earlier this week, the European Central Bank (ECB), whose head Christine Lagarde has recently raised questions about the central bank’s role in tackling climate change, published research which found that a green-only quantitative easing programme would not “significantly affect the stock of pollution”.