Eiopa, the European insurance regulator, is contemplating increasing capital charges on oil and gas bonds by as much as 40% to ready the sector for the net-zero target.
Insurers could face penalties if they invest in companies involved in fossil fuels, as indicated by plans discussed by EU regulators on Tuesday and Wednesday in Frankfurt (September 24-25).
This initiative could signify a pivotal moment in acknowledging the risks posed by climate change within the financial sector, an industry that frequently bears the financial burden of damages from floods and wildfires.
The forthcoming EU insurance law, which received political agreement last December and is now pending enactment, mandates that insurers must consider the societal and environmental damage caused by their assets, particularly focusing on investments in sectors like oil, gas, and coal.
Insurance law, Solvency 2, pertains to risk assessment and management, as stated by ShareAction policy officer Marika Carlucci in an interview with Euronews – highlighting that the transition away from fossil fuels presents immense risks ahead.
Assets linked to carbon-intensive sectors “are poised to lose value rapidly” as regulations propel the transition to a net-zero economy, Ms. Carlucci mentioned, adding: “If the value suddenly diminishes, the asset’s worth may be drastically reduced.” “A sudden collapse in value could result in financial instability.
This meeting follows a week after heavy rainfall caused widespread floods and led to mass evacuations in central Europe, which some have attributed to climate change.
The growing frequency of extreme weather events raises concerns about a “protection gap,” where certain global regions may become uninsurable and possibly uninhabitable.
Increase of 40
In December, the European Insurance and Occupational Pensions Authority (Eiopa) proposed raising capital charges by up to 40% for insurance companies exposed to fossil fuel liabilities.
Regarding equities, regulatory requirements could rise by 17%, making it less advantageous for insurers to invest in companies such as Shell or ExxonMobil.
“Climate change brings about transition risks associated with the decarbonization of the real economy“, the Eiopa consultation document states, citing the risk of “stranded assets” – investments that fail to align with a world devoid of fossil fuels.
National regulators overseeing Eiopa remain cautious and expressed doubts last June that the plan might deter investments.
They are reconvening today for a second time, and proponents of reform are optimistic about reaching an agreement.
“We hope that they [the supervisors] will endorse the Eiopa report, particularly regarding fossil fuel assets,” stated Julia Symon, head of research and advocacy at Finance Watch, a Brussels-based non-profit organization, in an interview with Euronews.
A retrograde vision
Ms. Symon dismisses concerns regarding the double counting of risks, arguing that current methods are inadequate for addressing unprecedented events like the future phasing out of fossil fuels.
“Insurers’ models are not suited to manage the current situation; their analyses rely on extrapolating from past data,” Mr. Symon asserted, contending that a clear EU position would result in strong and consistent regulation.
ADVERTISEMENTRegardless of what Eiopa decides, it will ultimately be up to the European Commission to determine how to incorporate it into law.
Maria Luís Albuquerque, the Portuguese commissioner for financial services, has been tasked by President Ursula von der Leyen with ensuring that the EU continues to be a “global leader in sustainable finance” – however, she has also been urged to eliminate unnecessary or incompatible regulations that hinder competitiveness, following a spate of green finance initiatives emerging from Brussels.
Symon and Carlucci emphasize that the effect on insurers’ performance is likely to be minimal.
Eiopa’s estimates indicate that solvency ratios will change by a few percent, whereas, in reality, most insurers exceed their regulatory minimum reserves by a multiple of two or three, noted Mr. Symon.
ADVERTISEMENTNevertheless, “it signifies a recognition of risk… the initial acknowledgment that it is indeed risky” for insurers to invest in firms whose business models may be nearing obsolescence, remarked Mr. Symon.
“We do not believe it undermines competitiveness,” Mr. Carlucci stated, adding, “It will enhance insurers’ competitiveness and ensure the resilience of their businesses in the future.
Eiopa’s Proposed Capital Charge Increase for Fossil Fuel Investments
Eiopa, the European insurance regulator, is weighing a significant policy shift that could reshape the financial landscape for fossil fuel investments. The proposal entails increasing capital charges on oil and gas bonds by up to 40%, a move designed to align the insurance sector with the EU’s ambitious net-zero targets.
The Shift in the Financial Sector
- Potential Penalties for Insurers: Insurance companies could face penalties if they choose to invest in firms engaged in fossil fuel extraction and use.
- Recognition of Climate Risks: This proposal marks a critical acknowledgment of the risks climate change poses, particularly to the financial sector, which bears the brunt of damage from extreme weather events.
- New Legislative Framework: The new EU insurance law mandates that insurers consider the societal and environmental harm their assets inflict, particularly in fossil fuel sectors.
Understanding Solvency Regulation
The core of the insurance law revolves around risk evaluation and management. According to Marika Carlucci, a policy officer at ShareAction, the transition from fossil fuels creates substantial financial risks:
- Carbon-Intensive Assets: Investments rooted in carbon-intensive sectors are at risk of devaluation as the world shifts towards a net-zero economy.
- Financial Instability: A sudden drop in investment value can lead to broader financial instability.
Recent Climatic Events and Their Implications
The urgency for such measures was underscored by recent climate-related disasters, including severe floods in central Europe. These incidents have raised awareness about a potential “protection gap,” wherein certain areas may become uninsurable due to climatic pressures.
Proposed Increase of 40%
In a significant development, Eiopa has proposed a capital charge increase of 40% for insurance companies’ exposure to fossil fuel liabilities, along with a 17% rise in prudential requirements for stocks tied to fossil fuel companies like Shell and ExxonMobil. This is expected to:
- Reduce Profitability: Make investing in fossil fuel companies less appealing for insurers.
- Highlight Transition Risks: Emphasize the financial risks posed by a transitioning economy that increasingly disfavors carbon-heavy assets.
Regulatory Challenges Ahead
While the Eiopa proposal has garnered support, national regulators have expressed concerns that higher capital charges could deter investments. Regulators remain divided on the implementation of these charges, which could shape future EU policies on insurance and climate change.
Julia Symon from Finance Watch remains optimistic, stating, “We hope that the supervisors will endorse the Eiopa report, especially regarding fossil fuel assets.”
Concerns Over Risk Management Models
Symon argues that existing risk management models are outdated and fail to account for the unprecedented nature of impending fossil fuel phase-out.
- Adaptation of Models: Insurers need to adjust their models to reflect current realities rather than relying on historical data.
- Uniform EU Stance: A cohesive EU approach could encourage more robust risk evaluations and management practices.
Future Steps for Eiopa and the EU Commission
Regardless of Eiopa’s decisions, the next phase involves the European Commission’s translation of these proposals into actionable legislation.
Maria Luís Albuquerque, the Portuguese Commissioner for Financial Services, has been tasked with ensuring the EU remains a leader in sustainable finance while balancing regulatory competitiveness.
The Impact of Proposed Changes
Despite fears of potential profitability losses, experts believe the changes will have minimal impact on the overall results for insurers:
- Solvency Ratios: Eiopa’s adjustments might alter solvency ratios by only a few percent, with many insurers already operating well above regulated reserves.
- Long-Term Resilience: Mr. Carlucci asserts that the proposed changes would enhance insurers’ competitiveness in the evolving market.
Conclusion: Emphasis on Risk Recognition
Ultimately, the discussions around increased capital charges for fossil fuel investments signify a significant turning point in the insurance sector. Mr. Symon emphasizes, “It’s the first recognition that investing in companies whose business models are on the brink of obsolescence is risky.”
With the landscape of investments changing rapidly under the pressures of climate change, the proposed capital charge increase serves as a critical step toward aligning the financial sector with broader environmental goals.
| Fossil Fuel Investment Risks | Potential Impact |
|---|---|
| Regulatory Compliance Costs | Increase in capital charges by up to 40% |
| Asset Devaluation | Risk of stranded assets in fossil fuel sectors |
| Financial Instability | Potential systemic risks from sudden market shifts |
| Insurance Market Changes | Transition to more sustainable investment practices |
