Insurance and ESG – Lexology

The increasingly noticeable negative effects of climate change have led to many regulatory initiatives and requirements in the insurance industry, both European and national. For this reason, and due to the increasing customer preferences for sustainable insurance and financial products, insurance companies will have to go through a sustainability transformation.

Considering the three dimensions of sustainability – environmental, social and governance (ESG) – in risk management and in other areas of the value chain (such as investment, pricing, sales, claims processing, product development or compliance) are among the key factors leading to a sustainable insurance industry.

ESG and risk management

From a functional perspective, risk management is a system of goals and processes for dealing with risk-related tasks in an insurance enterprise. It is designed to ensure that they continuously identify, measure, monitor, manage and report both existing and potential risks.

Accordingly, part of risk management is also defining, identifying, measuring, assessing and managing sustainability risks. These five steps provide the framework for ESG-compliant risk management. Both the Austrian and the German national competent authorities FMA and BaFin do not qualify sustainability risks as a separate type of risk in this context, but see the task of insurance companies to map sustainability risks into existing risk categories and integrate them into existing risk management ( the so-called “risk description”).

Multiple ESG risks can have a huge impact on an insurance company’s financial and revenue status. Areas of risk management such as asset/liability management, risk underwriting, investment risk management, provisions and reinsurance and other insurance risk reduction techniques may be particularly affected.

Various methods can be considered to identify, measure, assess and manage ESG risks, such as climate risk heat maps, CO₂ balance sheets, carbon footprint (or impact) analysis, stress tests and scenario analysis. The methods differ in the detail and trend they show. The granularity can range from an assessment of general indicators to a sectoral analysis. The trends to be mapped can either relate to the current state of specific indicators or attempt to map future risks. It is up to the insurance companies themselves to assess which methods are appropriate for their risk management.

Once a comprehensive overview of ESG risks is available, insurance companies must develop strategies and techniques to mitigate sustainability risks. Various methods can be considered for this purpose, but they must be consistent with the business strategy and risk strategy of the insurance undertaking. These methods may include negative screening, best-in-class approach and selling.

ESG and product development/underwriting

In their insurance, Austrian insurers already attach relatively high importance to ESG risks and sometimes act more consciously than their European competitors. Most attention is paid to the sustainability of insurance investment products as defined by the Sustainable Finance Disclosure Regulation (“SFDR”, Regulation (EU) 2019/2088). In property and casualty insurance, ESG’s focus is on covering climate-related risks and risks related to sustainable projects (such as e-cars). These use special tariffs and other environmental aspects (such as cover for energy-efficient home appliance upgrades in the event of a claim on household insurance policies) to provide incentives to take out policies. The methodology relies mainly on positive lists and exceptions.

ESG and distribution

The distribution of insurance is significantly affected by the comprehensive transparency requirements of the SFDR and the Taxonomy Regulation (Regulation (EU) 2020/852), including their delegated acts. These transparency obligations apply to both companies and products, with different disclosure obligations applying to different types of financial (insurance) products. Marketing measures and documents cannot contradict the disclosed information. Furthermore, from 2 August 2022, sustainability preferences must be taken into account when assessing the suitability of insurance and pension products, which of course affects not only direct distribution by insurance undertakings, but also distribution by insurance intermediaries.

Insurers are also subject to the changes in POG-DelReg (Delegated Regulation (EU) 2017/2358), which states that sustainability factors and targets must now (from 2 August 2022) also be taken into account in product management.

From here to where?

While sustainability already has a major impact on the insurance industry today, we can expect it to occupy and change the insurance industry even more in the future.

The implementation plan for the Sharm el-Sheikh Climate Change Conference, published on November 20, 2022, highlighted that “around US$4 trillion per year needs to be invested in renewable energy by 2030 to enable us to reach net zero emissions by 2050, and that, in addition, the global transformation to a low-carbon economy is expected to require an investment of at least US$4-6 trillion per year.” He also emphasizes that “providing such financing will require a transformation of the financial system and its structures and processes, involving governments, central banks, commercial banks, institutional investors and other financial actors’.

The insurance industry will certainly play an important role in this global transformation and its financing.

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