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The insurance industry, climate risks and capital requirements

The latest UN climate report delivers a ‘final warning’ to humanity about the impact of climate change, but the insurance industry is still funding and underwriting fossil fuel companies. Policymakers need to step in.

Better regulation of the insurance industry is needed to protect our planet and its people and to safeguard the industry itself.

As losses related to climate change are expected to increase we need stronger insurance companies – and that means safer levels of capital requirements.

Higher capital requirements for fossil fuel investments would also make these investments more expensive, pushing insurers to divert and divest from these sector – with a positive environmental effect for us all.

No matter how technical the topic of ‘capital requirements’ sounds, it boils down to a clear political question – do we want more, or less, burning of fossil fuels?

The European parliament is in the middle of heated negotiations to review the EU insurance legislation Solvency II. The EU supervisor for insurers and pension funds has been consulting stakeholders, in view of recommending changes to insurers’ capital requirements to take climate risk into account.

On 28 February 2023, we organised a roundtable on climate risks and insurers’ capital requirements in the EU (you can watch the recording here) where experts discussed the importance of net zero transition plans and higher capital requirements for fossil fuel investments.

We were pleased that nearly 100 people joined us online to listen to and engage with our brilliant speakers, including EU policymakers, supervisors, and civil society representatives. Here are some of the key messages that came out of the event.

The insurance industry needs to commit to phasing out fossil fuels

Large insurers continue to insure and invest in projects related to the extraction and burning of fossil fuels, contributing to the main cause of global warming.

Elana Sulakshana, Senior Energy Finance Campaigner with Rainforest Action Network (RAN) explained that “there's a massive gap between words and action – and the Net Zero Insurance Alliance does not appear to be stepping into bold leadership to close that gap. This is why we need insurance industry regulators to step in and safeguard the public good.”

Although 32 insurers have made commitments to achieve net zero greenhouse gas emissions as members of the Net Zero Insurance Alliance (NZIA), none have committed to phasing out fossil fuel underwriting in line with plans to prevent a global temperature rise of more than 1.5C.

As our briefing highlighted, we cannot rely on insurers’ voluntary initiatives. Now is the time to include crucial sustainability measures in the Solvency II Directive.

Net zero transition plans should be mandatory

MEP Henrike Hahn, Shadow Rapporteur on the Solvency II review for the Greens / EFA group, called for mandatory transition plans for insurers. The EU’s Corporate Sustainability Reporting Directive (CSRD) already includes a requirement for companies to disclose their transition plans. A specific requirement for insurers to develop transition plans with clear and measurable targets aligning their activities with the climate neutrality objective enshrined in the EU Climate Law is needed.

The recent vote on banking legislation in the European parliament’s Committee on Economic and Monetary Affairs is a good indication that European banks will be required to adopt transition plans. It would only be logical to level the playing field and place the same requirements on European insurers.

Yet transition plans alone would not protect banks or insurers from becoming insolvent should they face unexpected losses – which, as the recent cases of banks in the United States and Switzerland show, can happen very quickly.

Climate change is unprecedented – we need a precautionary approach to financial regulation

Panellist Gabrielle Siry, Head of Sustainable Finance & European Cooperation at the French Prudential Supervision & Resolution Authority (ACPR), estimates that climate change could mean a doubling of costs for insurance companies by 2050: “It means that insurers will need sufficient capital to face these risks and these damages and carry on their mission for citizens and businesses.”

But safeguarding insurers and society at large against new risks and costs is tricky because so far financial regulation and supervision have largely relied on historical data to measure risks and regulate the financial sector.

When it comes to climate change, and the transition to a low-carbon economy triggering a loss in value of high-carbon assets like fossil fuels (so-called ‘transition risk’), there is of course no straightforward data to rely on – because those phenomena are unprecedented in history.

If policymakers and financial supervisors are to address the risks of climate change, they need to move from a reliance on historical data to a forward-looking approach.

In our response to EIOPA’s consultation on the topic, we detail this need for an evidence-based precautionary approach to insurance regulation and capital requirements.

There should be higher capital requirements for fossil fuel investments

Scientific evidence has established the need for speedy decarbonisation and the complete end to new fossil fuel exploration. Policymakers and regulators should consider that all investments in companies involved in the new exploration, expansion or development of fossil fuel projects and related infrastructure are particularly risky, and should be regulated accordingly.

This is why we’re calling for the adoption of a one-for-one rule whereby investments in companies involved in new fossil fuel projects would be subject to a 100% capital charge.

Such a precautionary approach to how we regulate insurers’ involvement in (new) fossil fuel projects would not only protect the insurance sector itself against unforeseen risks and losses but would also positively contribute to the green transition.

Indeed, the good news is that higher capital requirements for fossil fuel investments will also make it more costly for insurers to insure and invest in these types of projects.

A precautionary approach to the regulation of insurers’ involvement in (new) fossil fuel projects would thus protect the insurance sector itself and positively contribute to the green transition by encouraging insurers to move away from the fossil fuel sector.

👉 Sign this petition to encourage EU policymakers to better regulate the insurance industry, and to recognise the high environmental and social costs of fossil fuel investments.

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