Assessing the impact of sustainable finance on insurance entities

Thu 04 Mar 2021

Amid a global pandemic and a rising threat of climate change, today’s society expects financial organisations to uphold strong environmental and societal values. Given their critical role in the growth of the economy and citizens’ lives, insurers face close scrutiny.

As a result of the growing focus on ESG issues, sustainable finance is now gaining ground in the minds of even the most sceptical investors. In the first quarter of 2020, Morningstar reported 51 of its 57 ESG-screened indices, or 89%, outperformed their broad market equivalents¹, while MSCI found that 15 of its 17 ESG indices performed similarly². Even during the COVID-19 crisis, ESG indices held up better than their non-ESG equivalents. It would, therefore, appear that companies with sustainable profiles are more resilient in the long term and robust in times of crisis.

With the benefits of sustainable finance becoming more widely known and accepted, financial organisations are expected to play their role. As institutional investors, intermediaries, financial product designers and risk managers, insurance companies are among the first to be impacted by the transition to sustainable finance. The priority for regulators lies in clarifying the requirements for disclosing non-financial information to enhance transparency around integrating ESG criteria by issuers and investors to gain public confidence. Over the years, sustainable finance was developed through international “soft law”, but recently binding ”hard law” regulations have emerged throughout the European Union. The European regulation on sustainability-related disclosures in the financial services sector, which came into force in January 2020, will be applicable throughout Europe in March 2021.

Faced with such regulatory and technical changes, financial and insurance regulators have set up specialist commissions. This new development presupposes an increased risk of sanctions for players who do not respect the sustainable and responsible investment commitments they may have made. Such actions pose several challenges for insurers.

Managing risk exposure

When confronted with investments in the financial markets, insurance players are exposed to risks and sustainability issues, whatever the nature of their life and non-life products. If we take the impact of applicable regulation, the Solvency 2 prudential rules’ primary objective is to maintain financial stability. These rules are likely to hinder the growth of long-term investments. For this reason, ESG and sustainability issues call for an adaptation of the existing Solvency 2 requirements. Furthermore, the development of regulations that supervise responsible action by insurance companies has been ongoing for several years now.

In terms of risk, it is recognised that every entity is defined by a specific risk profile and is fully able to limit its exposure to sustainability risks. Nonetheless, particularly in light of the regulatory changes, the rising number of claims linked to climate change, and the increasing judicialisation of environmental damage, insurance companies can no longer ignore the reality of the impact of sustainability risks. For insurance companies, sustainable development issues lie at the heart of their risk management policy, whether these pose strategic risks, climate risks, operational and organisational risks or financial risks.

In addition, the challenges of sustainable finance have a practical impact on the entire value chain of insurance companies offering products backed by financial securities. Whether through compliance with dedicated regulations, integrating a specific risk typology, or at the heart of their value chain, insurance companies are directly impacted by ESG issues.

How insurance companies now manage the impact of regulations applicable across Europe as of March 2021 will help highlight strong environmental and societal values insurers hold and boost public confidence in the transition to sustainable finance.

[1] How Did ESG Indexes Fare During the First Quarter Sell-off? | Morningstar ; [2] MSCI ESG Indexes during the coronavirus crisis – MSCI ; [3] https://eur-lex.europa.eu/legal-content/FR/TXT/PDF/?uri=CELEX:32019R2088 .