On 5 December 2022, the European Insurance and Occupational Pensions Authority (EIOPA) published a lengthy discussion paper on the “Prudential Treatment of Sustainability Risks” (the Discussion Paper). This is an important Discussion Paper for European (re)insurers as it is a likely precursor to EIOPA’s anticipated mandate from the European Commission under Article 304a of the Solvency II Directive.  This mandate requires EIOPA to assess if a dedicated prudential treatment of assets and activities associated substantially with environmental or social objectives is required under Solvency II.

EIOPA acknowledges the importance of insurance regulation appropriately addressing, from a risk-based perspective, the influence of sustainability risks underlying investment and underwriting activities.  In the Discussion Paper, EIOPA outlines the intended scope, methodologies and data sources for its analysis.

EIOPA has focused its assessment on three distinct areas of analysis:

1. Assets and transition risks exposure: this section of the Discussion Paper considers insurers’ investment activity and how they may be exposed to transition risks arising from a potentially rapid change towards a lower carbon economy.  It also considers the potential knock-on impact on prudential risks related to stocks, bonds and real estate. Significantly for (re)insurers, EIOPA is currently looking at assessing the potential for a dedicated treatment of transition risk exposures in solvency capital requirements.
2. Underwriting risk and climate change adaptation: this area of analysis concerns how the possible effect of climate-related adaptation measures on underwriting risk and related loss exposure may impact the non-life insurance sector.  In particular, EIOPA examines the increasingly high number of claims arising from climate-related natural disasters, including property damage and business interruption claims. Notably, EIOPA is considering a dedicated prudential treatment of climate-related adaptation measures on non-life underwriting risks in the Solvency II standard formula.
3. Social risks and social objectives from a prudential perspective: this section of the Discussion Paper focuses on how ‘social objectives’ and ‘social risks’ are defined and considers how these aspects equate to prudential risks and direct financial losses for (re)insurers. EIOPA is initially focused on assessing the prudential treatment of social risks in the context of Pillar II and Pillar III requirements under the amended Solvency II delegated regulations.

Timing and Next Steps

EIOPA is seeking comments on the Discussion Paper by 5 March 2023. EIOPA confirms that it will use the feedback received to improve its methodologies. EIOPA also intends to publicly consult on the empirical findings from its analysis and possible policy implications in the near future.  More generally, the Discussion Paper provides some very dense but thought-provoking reading for Irish (re)insurers in considering how sustainability risks may appropriately be assessed through the ORSA process.

To view the Discussion Paper in full, please see here.

Contributed by Cliona Walsh