Insurance and ESG

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 growing customer preferences for sustainable insurance and financial products, insurance undertakings will have to undergo a sustainability transformation.

Consideration of the three sustainability dimensions – environment, 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 objectives and processes for handling risk-related tasks in an insurance undertaking. It is designed to ensure that they continuously identify, measure, monitor, manage and report on both existing and potential risks.

Accordingly, part of risk management is also to define, identify, measure, assess and manage 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 undertakings as mapping sustainability risks in the existing risk categories and integrating them into existing risk management (so-called "risk inventory").

The multitude of ESG risks can have a massive impact on an insurance undertaking's financial and earnings situation. Risk management areas like asset/liability management, risk-taking, investment risk management, provisioning, and reinsurance and other insurance risk mitigation techniques can be particularly affected.

Various methods can be considered to identify, measure, assess and manage ESG risks, such as Climate Risk Heat Maps, CO₂ Balances, Carbon Footprint (or Impact) Analysis, Stress Testing and Scenario Analysis. The methods differ in granularity and the trend they indicate. The granularity can range from assessment of general indicators to sectoral analysis. The trends to be mapped can either relate to the current status of specific indicators or attempt to map future risks. It is up to the insurance undertakings themselves to assess which methods are suitable for their risk management.

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

ESG and product development/underwriting

In their underwriting, Austrian insurers already attach comparatively great importance to ESG risks and sometimes act more deliberately than their European competitors. The most attention is paid to sustainability in insurance investment products as defined by the Sustainable Finance Disclosure Regulation ("SFDR", Regulation (EU) 2019/2088). In property and casualty insurance, the ESG focus is on coverage of climate-related risks and risks relating to sustainable projects (such as e-cars). For these, special tariffs and other greening aspects (such as coverage for energy-efficient modernisation of household appliances in the event of a claim under household insurance policies) are used to provide incentives to take out policies. The methodology mainly relies on positive lists and exclusions.

ESG and distribution

Insurance distribution is significantly impacted 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 may not contradict the disclosed information. In addition, since 2 August 2022, sustainability preferences must be considered when assessing the suitability of insurance and pension products, which of course not only affects direct distribution by insurance undertakings, but also distribution by insurance intermediaries.

Insurers are also subject to the changes in the POG-DelReg (Delegated Regulation (EU) 2017/2358), which stipulates that sustainability factors and objectives must now (since 2 August 2022) also be considered in product governance.

Where do we go from here?

While sustainability is already having 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 of the Sharm el-Sheikh Climate Change Conference, published on 20 November 2022, highlighted that "about USD 4 trillion per year needs to be invested in renewable energy up until 2030 to be able to reach net zero emissions by 2050, and that, furthermore, a global transformation to a low-carbon economy is expected to require investment of at least USD 4–6 trillion per year." It also highlighted that "delivering such funding will require a transformation of the financial system and its structures and processes, engaging governments, central banks, commercial banks, institutional investors and other financial actors."

The insurance industry will certainly play an important part in this global transformation and its funding.

authors: Peter Konwitschka, Daniel Höhnl