How European insurance regulators are responding to climate risk

In 2016, the UN Secretary General at the time laid down five challenges to the insurance industry^[1]:

1. Measure the carbon footprint of investment portfolios by 2020 and decarbonize investments
2. Double investments in sustainable energy by 2020
3. Develop auditable standards in the insurance industry that incorporate the Sustainable Development Goals (SDGs)
4. Work with the UN to ensure that early warning and action systems are made available to the most vulnerable countries by 2020
5. Provide the most vulnerable with greater access to risk transfer mechanisms

A report from the UN Environment Inquiry into a Sustainable Financial System^[2] concluded that “In its role as risk manager, risk carrier and investor, insurance is at the heart of a sustainable financial system.“. Yet, Mark Carney, former Governor of the Bank of England, stated^[3] the insurance companies should be wary of “cognitive dissonance” where climate risks that may be well managed by underwriters, may be ignored by portfolio managers.

According to several industry assessments^[4], insurers are largely failing in their efforts to achieve many of these ambitions mentioned above. DWS’s analysis of 35 major European listed insurance companies found only 15 companies with an A or B score in our ESG rating (which combines four different data providers) and only four companies with an A or B score in our SDG rating. However, in September 2019 a number of major European insurance companies became founding members of the Net Zero Asset Owners Alliance which has a strong focus on engagement. This may assist in boosting sustainable energy investments, which still fall short of the UN Secretary General’s 2016 ambitions as do incorporating metrics relating to the SDGs.

While European insurers tend to lead the global insurance industry when it comes to ESG, efforts among European insurance supervisors and regulators to improve climate risk management standards have been accelerating over the past few years. This is being undertaken to address the exposure of the insurance sector to the three channels of climate risk namely physical risk, transition risk and liability risk, which affect both sides of an insurer’s balance sheet, Figure 1.

In this article, we examine the various approaches being adopted by insurance regulators across the European Union. We find that the methods by which supervisors and regulators are approaching climate risk management can be classified into five categories^[5]:

1. Integrating climate factors into supervisory risk rating frameworks to assess traditional financial risks such as market risk, credit risk, liquidity risk, operational risk and reputational risk
2. Strengthening disclosure of climate-related information by insurers through voluntary or mandatory public disclosure requirements
3. Integrating climate into routine supervisory tools such as own risk and solvency assessment (ORSA)
4. Integrating climate risk into financial stability assessments, and stress tests
5. Undertaking forward-looking climate scenario analysis

With the Sustainable Development Goals, including the climate crisis, representing both macro and micro risks and investment opportunities, the above statement from Christiana Figueres in 2015 is very apt. We would add that insurance regulators should also not underestimate their power and responsibility to help strengthen the insurance sector’s key roles as societal risk manager, risk carrier and investor in a way that accelerates action on the climate crisis.

To assess ESG and SDG alignment within the insurance sector, the DWS’s ESG Enginecombines multiple ESG data sources to create ratings on ESG factors, the SDGs among others with underlying data available to all our portfolio managers. Figure 2 shows the distribution of scores by number of companies for thirty-five major European insurance companies. Of these, a majority (88%) have an ESG score between A and C. When examining their ESG score with their business revenue aligned to the SDGs, only 20% are rated at C or above.

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