Insurance Supervisory & Regulatory approaches to climate-related risk

Insurance Europe call for supervisory and regulatory approaches to climate-related risk that reflect realties of insurance business.

There is no evidence to say that insurers are particularly vulnerable to system-wide impacts from climate change. Systemic risk emanating from climate change is neither faced nor transmitted by insurers: rather, it is faced by society as a whole.

Insurance Europe has responded to a consultation by the Financial Stability Board (FSB) on its consultative report on supervisory and regulatory approaches to climate-related risk.

The FSB, standard-setters and supervisors should take into account the developments in reporting and availability of consistent climate-related data from the real economy, and avoid repetitions and inconsistencies with existing or upcoming initiatives. Furthermore, a truly global risk like climate change demands a globally coordinated approach.

The European insurance industry welcomes the intent of the FSB Interim Report to achieve cross-sectoral consistency and to consider interactions between sectors, in line with the FSB roadmap for addressing climate-related financial risks. A truly global risk like climate change demands a globally coordinated approach.

The insurance industry highlights the following:

1. While data quality is essential, it should be noted that it is not a new topic. Supervisors can rely on processes already in place to ensure the reliability of the supervisory reporting on the one hand, and the financial and non-financial public filings on the other. At the same time, there should be an understanding that the insurance sector is dependent on other sectors’ data and data quality and external models.
2. On the one hand, increased third party verification would result in higher data quality, but on the other hand it would also lead to higher costs.

As the FSB roadmap notes, policymaking requires, as general pre-conditions in particular, reliable information, appropriate diagnostics, and effective policy instruments. In a similar vein, pre-conditions are required for private institutions to duly take account of climate-related risks in their risk management. Insurance Europe remains convinced that the FSB has a major role to play in helping realise these pre-conditions.

Tools such as stress tests, which are still exploratory in nature, should only be used to identify indications for relevant issues and require further work before being used to draw conclusions. It is important to avoid false accuracy, over-complication and granularity by focusing on materiality to avoid placing excessive burdens on insurers. It is too early to develop new tools for the insurance sector other than continuing the development of monitoring tools, such as climate stress tests.

Key messages for Insurers

Supervisory and regulatory reporting and collection of climate-related data from financial institutions

• The Financial Stability Board (FSB) has highlighted the lack of climate-related data from the real economy for policymakers and supervisors to assess climate-related risks effecting the insurance industry and other financial institutions. This data gap, along with inconsistencies in the data that is available, are deterring them from effectively addressing climate-related financial risks and delivering on the Paris Agreement.

• In the EU, the availability of data should improve significantly thanks to the ESG reporting initiatives that are under way in different jurisdictions: eg the Corporate Sustainability Reporting Directive (CSRD) and European Single Access Point (ESAP) at the EU level. These initiatives will allow European insurers to fully realise their transition plans, to better assess their climate-related risks and exposures, and to conform their reporting as required by the Sustainable Finance Disclosure Regulation (SFDR) and Taxonomy Regulation.

• The FSB, standard-setters and supervisors should take into account the developments in reporting and data availability to avoid repetitions and inconsistencies with existing or upcoming initiatives. A truly global risk like climate change demands a globally coordinated approach.

System-wide supervisory and regulatory approaches to assessing climate-related risks

• There is no evidence to justify the conclusion that insurers are particularly vulnerable to system-wide impacts from climate change. Climate change realises over time and insurers can adjust policies, investments, underwriting, pricing and decisions on risk coverage. Systemic risk per se is not faced and transmitted by insurers. It is rather faced by society.

• Appropriately designed climate stress tests can provide information to help assess financial industry exposures. However, the starting point should not be a premature conclusion that insurers are vulnerable to climate-related risks.

• Given the exploratory nature of the stress test, and particularly given the limited data availability and robustness challenges, it is important to recognise that it can only give indications for relevant issues and needs further work before drawing conclusions.

• Stress tests should avoid false accuracy, over-complication and granularity by focusing on materiality to avoid placing excessive burdens on insurers.

• The insurance industry supports good practice and agrees that standardisation/harmonisation is needed, to a certain extent, in relation to modelling and stress testing to allow for (financial) sector-wide comparability.

• In the case of publication, it is critical that only sector-wide information – and not individual company information – is published.

Early consideration of other potential macroprudential policies and tools to address systemic risks

• In terms of system-wide approaches to assess climate-related risk, there is no indication or evidence of any systemic risk faced by insurers relating to climate risk. It is, therefore, premature to already develop new tools for the insurance sector other than continuing developing monitoring tools, such as the climate stress tests.

• Any development of macroprudential tools in the future, if evidenced, has to be based on a comprehensive cost benefit analysis, including a full assessment of potential downsides and unintended consequences before making proposals for consultation.

Regulatory/supervisory overshoot and/or macroprudential measures triggered at bad timing would be counterproductive and can undermine financial stability and delay the climate transition.

The most effective mitigant of macro-risks is companies’ own progress on measuring and addressing climate risk, combined with micro-prudential supervisory tools.

The monitoring and assessment of climate-related financial risks, by the private sector and financial authorities, however, crucially rests on comprehensive and robust international climate-related data. While the insurance sector has made good progress on data and climate-related risk practice on its own, gaps in data from the real economy remain significant. These gaps are a major shortcoming when it comes to informed investment and underwriting decisions; and they are an impediment to develop more mature, transparent and robust models. Data consistency and gaps must therefore be areas of concern to the FSB too.

In relation to supervisory reporting, key elements in (micro-)prudential supervision, namely materiality, proportionality, and confidentiality, should be equally reflected in any macroprudential assessment and macroprudential policy tools. It is important that supervisors have a good understanding of the climate risks landscape across financial sectors while also taking note of different business models.

While the FSB makes references to a number of jurisdictional developments that do mention materiality, the FSB report insufficiently emphasises the concept.

Insurance Europe therefore recommends reflecting materiality in the FSB recommendations. It is also key that any information request by supervisors is carefully considered and proven to be essential for fulfilling their supervisory duties.

Multiplication of parallel and similar, but not identical, requests should be avoided. These considerations form essential aspects for the peer review of regulatory and supervisory practices against the FSB guidance foreseen in 2023 in avoiding excessive burden on both supervisors’ and insurers’ sides.

Supervisors should engage and communicate to financial institutions how and for what purposes the reported data will be used. Any reporting mandate should respect the principles of confidentiality, proportionality, and materiality. In any case, it is important that insurers have flexibility in their approaches while being mindful of consistency and comparability where relevant and possible. There is no one-size-fits-all approach, and insurers’ practices continue to evolve. Models for measuring climate-related risks and exposures are being developed and refined, and materiality of climate-related risks will change over time.

Consequently, supervisors should continue to support risk-based prudential rules and focus on Pillar 2 (risk management, governance) and 3 (reporting) elements. Allocating capital to risks that may or may not occur in 20-30 years’ time could cause unintended consequences and more fundamental system-wide risks: for example, by making insurance too expensive leading to under-insurance and increasing the insurance gap, which would make society less resilient to climate change.