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.