The European Insurance and Occupational Pensions Authority (EIOPA) has released its latest sustainability proposals (EIOPA-BoS18/483), which are wide ranging and could have significant implications for insurers’ investment strategies, risk and actuarial functions, product pricing, design and sales processes. They involve amendments to Solvency II and the Insurance Distribution Directive to integrate sustainability factors, and where relevant, reflect policyholders’ environmental, social and governance (ESG) preferences. This follows the Prudential Regulation Authority’s (PRA) recent proposals in CP23/18 on the financial risks of climate change, which were covered in a recent blog.
Investment Strategy and Prudent Person Principle (“PPP”)
Insurers should account for sustainability risks when assessing the security, quality, liquidity and profitability of the portfolio as a whole in the light of the Prudent Person Principle. EIOPA noted that there is currently a lack of evidence that insurers consistently consider sustainability risks in their investment strategy.
EIOPA is also seeking to embed sustainability into both sides of investment. Insurers will be required to assess the impact of their investment activities on sustainable economic activity, considering their engagement strategies and stewardship and the impact on the investment of sustainability risks. Insurers’ investment portfolios will also need, where relevant, to reflect policyholders’ ESG preferences.
Insurers’ risk management systems will need to capture sustainability risks. For climate-related risk, both physical and transitional risk should be considered as specified in the Financial Stability Board’s Task Force on Climate-Related Financial Disclosures and subsequently used by the PRA. Liquidity should be assessed. EIOPA believes that more sustainable investments will be easier to sell due to market preferences and therefore more liquid going forwards. The impact on insurance liabilities and concentration risk should also be considered.
Sustainability risks should also feature in the own risk and solvency assessment (ORSA), especially in respect of climate change, which is explicitly mentioned in the paper, as is EIOPA’s expectation of greater quantitative rigour given the availability of different scenarios.
Underwriting opinions will need, where appropriate, to consider sustainability risks.
Insurance Distribution Directive
Sustainability considerations will need to be included in assessments to identify possible conflicts of interest that might adversely impact the interests of customers and / or result in mis-selling. Possible examples cited include differences between products investment strategies (and the exercise of shareholder rights) and policyholders’ ESG preferences.
Product approval processes will need to be changed to take into account ESG factors if products are intended to be distributed to customers interested in products with an ESG profile.
This may potentially be more onerous that it first appears. Not asking what a customer’s ESG preferences are would not seem to be an option. And unless an insurer is only actively marketing to a customer base that has been predetermined as having no ESG preferences (which would seem unlikely), it appears to implicitly compel the insurer to either offer a range of ESG profiled products to cover the potential range of preferences of its customers or not sell products to those customers.
As the European Commission’s taxonomy has yet to be finalized, insurers and intermediaries will need to clearly specify criteria applied to define ESG preferences and how they compare with current market standards. Ongoing monitoring and review will be important to ensure investment assets remain within the ESG definition and customer preferences.
EIOPA’s proposals represent the biggest and most ambitious step forward in a sustainable investment policy for insurers to date. Investment professionals will need to assess their portfolios before regulatory changes begin to impact valuations – timing as always will be critical. The sooner action is taken the larger the opportunity in de-risking balance sheets and portfolios.
However, the proposals are likely to impact businesses far beyond investment policy, with staff needing to quickly upskill and be able to demonstrate the skills, knowledge and expertise that regulators will expect and to act in a consistent manner across all aspects of the business.
Gap analyses and action plans will be needed, as will an understanding customer ESG preferences.
2019 is shaping up to be the year in which all insurers will need to act in this area.
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