Insurance industry reassessing fossil fuel investments in light of EIOPA's push for greener portfolios?
In a significant development, the European Insurance and Occupational Pensions Authority (EIOPA) has proposed additional capital requirements for fossil fuel assets on insurers' balance sheets. These new requirements are designed to reflect the higher financial risks associated with fossil fuel investments due to climate-related transition and physical risks [1][3].
According to EIOPA's new approach, fossil fuel assets face higher levels of exposure to transition risks, which are not yet adequately reflected in current pricing [1]. As a result, insurers may be required to set aside more capital against these high-risk investments, which could reduce the available capital on their balance sheets for other uses and increase the overall capital costs of holding such assets [1][3].
This change could lead insurers to reduce their allocations to fossil fuel assets and shift investments towards greener, less risky assets to optimize capital efficiency and comply with the new prudential requirements [1][4]. However, EIOPA's proposals are not expected to impact insurers' credit ratings, suggesting a managed transition rather than abrupt financial strain [5].
The proposed capital requirements for investments in fossil fuel shares are 17%, and for equities up to 40% [2]. Under Solvency II, the regulatory framework governing the European insurance sector, insurers and reinsurers are required to hold a certain amount of liquid assets to cover potential losses in a given year [6].
The move has been welcomed by climate campaigners who see it as a clear message to insurers to review their exposure to fossil fuels. However, it is important to note that EIOPA's proposals could have a marginal impact on insurers' asset allocation, according to rating agencies like Fitch Ratings [7].
The new requirements also signal an increased regulatory scrutiny on sustainability risks in insurers' portfolios, encouraging enhanced internal procedures to assess and manage exposures related to fossil fuels and climate change risks, which could influence insurers' overall investment behavior towards more sustainable practices [3].
Anand Rajagopal, from the Phoenix Group's asset management division, acknowledges the potential signalling power of EIOPA's recommendations for UK insurers. He suggests that insurers may reconsider their decisions to remain invested unless they see positive changes in sector or issuer behaviour through engagement or stewardship efforts [1].
Ludzuweit, from MSCI, emphasizes the importance of consistent multi-horizon climate scenario analysis and location-based stress testing tools for investors. She also cautions against exclusion strategies due to higher tracking errors and potential liquidity risks [4].
The UK PRA has noted that all insurers may need to factor in climate risk within their overall investment process, and the UK Government is considering climate risk add-ons to the Fundamental Spread [8].
In summary, EIOPA's proposed additional capital requirements for fossil fuel assets would likely lead to a shift in insurers' investment behaviour, with a focus on more sustainable practices and reduced exposure to high-risk fossil fuel assets. This regulatory approach is part of a broader push in the EU to align financial sector investment with climate goals and ensure resilience against transition risks in high-emission sectors.
| Impact Area | Expected Effect | |----------------------------|---------------------------------------------------------------| | Balance sheets | Higher capital buffers against fossil fuel assets, reducing available free capital[1][3] | | Investment behavior | Possible divestment from fossil fuels and increased green investments for capital efficiency[1][4] | | Credit ratings | No expected direct impact according to EIOPA, indicating measured risk management[5] | | Risk management | Stronger procedures to address sustainability risks, integrating climate scenario assessments[3] |
In light of EIOPA's proposals, insurers may need to adopt stronger risk management practices to assess and manage exposures related to fossil fuels and climate-change risks [3]. These new requirements also indicate an increased focus on environmental-science related issues in the financial sector, as insurers shift their investments towards greener, less risky assets to optimize capital efficiency and comply with the new prudential requirements [1][4].
