Sustainability and Climate Change: Main positions of the AAE
The current Assessment Report 6 of the IPCC is quite clear: “Emissions of greenhouse gases from human activities are responsible for approximately 1.1°C of warming since 1850-1900” and “many of the changes observed in the climate are unprecedented in thousands […] of years.” Warming beyond 1.5°C will increase physical consequences significantly. At approximately 2°C irreversible tipping points in the climate system will be reached. Consequently, almost all countries committed in the 2015 Paris Agreement to a 1.5°C warming target and this target has been confirmed at the COP26 in Glasgow 2021.
The European Commission sees insurance and pensions as playing a prominent role in supporting Europe achieve the required targets. Investment processes, as well as the provision of insurance and reinsurance can play a key role in the transition towards a sustainable economy. Sustainability principles already form a pivotal ingredient in how insurance and pensions protect against severe events for both individuals and for organisations and in how they ensure financial security in old age. We need to ensure that the insurance and pensions industry stay true to these principles by addressing the following three questions:
- How can we effectively manage the risks posed to insurance and pension systems from short and long-term policy impacts of climate change and other environmental or social trends?
A key principle of Solvency II remains central: “same risk – same capital”. If so-called ‘green supporting’ or ‘brown penalising’ factors are introduced into Solvency II capital requirements, they should be scientifically based and reflect the quality of the investments and their inherent risks. Obviously, we must acknowledge that the integration of emerging risks cannot rely solely on historical statistics but needs to factor in forward-looking considerations.
We support already proposed initiatives that contribute to an appropriate integration of climate risk in the Solvency II framework, e.g., climate scenarios in the ORSA and regular reviews of the Nat Cat model of the standard formula.
For savings products in pensions and insurance, it is important for policyholders to be well informed about the investment strategy and the sectors in which their money will be invested. We support a transparent classification of savings, pensions and investment products by ESG criteria and a clear and informative sales process to support policyholders’ decisions.
- How can insurance and pensions contribute to the needed transition through investment policy and transition project insurance as well as via pay-outs linked to climate related physical risks which are insurable?
As long-term investors, pension funds and insurers can also play a relevant role in financing the desired transition to a more sustainable future with a reduced carbon footprint. It should be noted that, due to the long-term investment strategies in place and the duty insurers have to service existing guarantees in long-term products, some investments held by insurers may not be practically capable of being resold immediately. In addition, we expect that indirect incentives, like green supporting or brown penalising factors under Solvency II, might be justified but might not necessarily have the full envisaged effect just by themselves, as risk capital sometimes plays only a secondary role in investment decisions. However, some assets may become stranded assets and we encourage pension funds and insurers to anticipate these asset transition risks.
We support the direct facilitation of specially structured green bonds relating to debts or loans for transition projects. Such structures could make direct support of transition projects more attractive for insurers and pension funds because of their long-term horizon, attractive interest rate expectations, stable guarantees potentially provided by governments and transaction sizes that may be accessible to smaller undertakings.
Non-life insurance can play a major role during the transition in protecting companies against physical losses and by providing supporting services. Here, we believe that underwriting approaches that include ESG criteria in the assessment of risk exposures are important for developing sustainable solutions that price climate change risks appropriately.
- For climate risks borne by society which are not currently insurable or may become uninsurable as market conditions evolve, how can public policy work with insurance and pension systems to ensure that society is covered in these areas?
Insurance protection gaps, by definition, are areas in which societal risks are not covered by the insurance industry. Especially when the risks are uninsurable as insurers are adopting well-informed underwriting processes and thus decline some coverages, these risks might only be covered by public policy encouragement. We support the early identification of potential protection gaps arising from climate change and the development of joint solutions between the insurance industry and public protection facilities where appropriate.
Climate change is not just a European issue. Solving the climate crisis will need action not only from European actuaries and insurance and pensions undertakings. We also need a global view. Ideally, there should be no worldwide inconsistencies or local European regulatory loopholes that can be exploited to manoeuvre around risk-based and scientifically evaluated assessments of any of the topics mentioned above. We as the AAE stand ready to support the development of comprehensive, proper carbon and pollution accounting and valuation approaches to make any such loopholes more transparent.
This blog is based on the AAE position Sustainability and Climate Change, published in December 2021.
The AAE position was shared in the recent webinar ‘Sustainability and Climate Change – what does it mean for risk management in Insurance and Pensions? held on 1 February 2022.
7 February 2022