The Sustainability Legislative Framework for Insurers

Sustainability at the microeconomic level is rooted in the 17 Sustainable Development Goals (SDGs) of the United Nations (UN), adopted in 2015. These goals cover a wide range of topics such as poverty, inequality, justice, urbanization, education, and climate action, among others. Climate action, specifically, is the 13th goal. At the time of their adoption, climate change was not yet a top priority as highlighted by the CRO Forum. However, recent trends have shown a significant shift. 

The following figure illustrates the top five global risks over the years, revealing that while past concerns were centered around non-systemic extreme events, the failure to adequately address climate change has elevated extreme weather events to the forefront of societal risks in the last four years.

The Paris Agreement of 2015 underscores the link between climate change and poverty—eradicating the latter being the first SDG. The Agreement outlines three strategies to combat climate change:

1. Limiting global temperature increases to 2°C above pre-industrial levels.

2. Enhancing the ability to adapt to the adverse impacts of climate change.

3. Aligning financial flows with low greenhouse gas emissions and climate-resilient development.

The insurance sector plays a pivotal role in supporting the second and third strategies. Insurers can accelerate recovery from extreme weather events by offering effective natural catastrophe (NatCat) insurance. Premium rates for NatCat policies can also incentivize physical resilience by linking costs to property preparedness against natural disasters. Regarding financial flows, insurers are key participants in financial markets and can drive investments toward low-carbon economies.

The Principles for Sustainable Insurance (PSI), established by the United Nations in 2012, aim to foster a "risk-aware world" by promoting the assessment, management, and monitoring of environmental, social, and governance (ESG) risks. These principles encourage all participants in the insurance value chain to act responsibly and with a forward-looking perspective.

On April 21, 2021, the European Commission (EC) adopted amendments to Delegated Regulation (EU) 2015/35 through Regulation (EU) 2021/1256 and Regulation (EU) 2021/1257. These amendments aim to integrate sustainability considerations into insurers' governance systems, and insurance pricing and distribution systems. Notably, Article 272 from (EU) 2021/1256 now requires the actuarial function to account for sustainability risks when pricing insurance, explicitly assigning the actuarial community responsibility for analyzing such risks.

At the time of writing, proposed amendments to Solvency II are under discussion in the Council of the European Union. Document Procedure 2021/0295, dated September 22, 2021, suggests amendments regarding sustainability risks, including two new articles:

• Article 45a: Requires insurers, except those classified as "low-risk," to assess material exposure to climate change risks and use at least two climate scenarios to project business development over the short, medium, and long term.

• Article 304a: Assigns the European Insurance and Occupational Pensions Authority (EIOPA) two responsibilities:

  1. Supervising the prudential treatment of exposures and assets to ensure consistency with the EU's sustainability policies.

  2. Reviewing the parameters of the Non-life Natural Catastrophe Risk sub-module of the Solvency Capital Requirement (SCR) every three years, incorporating the latest evidence on climate change.

The proposed amendments to Solvency II emphasize climate change risk, a subset of sustainability risks but arguably the most significant for insurers. This focus reflects the urgent need to address the tangible and far-reaching impacts of climate change on the insurance sector, including operational strategies, risk modeling, and financial stability.

Anticipating its role in integrating climate change risks into the prudential framework for insurers, in 2021, EIOPA issued an opinion (EIOPA-BoS-21-127) on incorporating climate change scenarios into the Own Risk and Solvency Assessment (ORSA) reports. This initiative responded to the amendments introduced by Regulation (EU) 2021/1256. The EIOPA's Opinion establishes foundational principles for this integration:

• Materiality Assessment

EIOPA emphasizes the need to evaluate how climate change risks may affect insurers' operations, business strategies, and solvency positions. Insurers are expected to identify and prioritize these risks in a structured manner.

• Quantitative Analysis within a Climate Change Scenario Framework

EIOPA recognizes that initial reports may rely on qualitative and general assessments. However, the authority expects a progressive shift toward more robust quantitative analyses using well-defined climate change scenarios. Future reviews will scrutinize the depth and quality of these assessments.

• Short- and Long-Term Perspectives
   

Both time horizons are equally critical. In the short term, climate change manifests through more frequent and severe extreme weather events. In the long term, insurers will face evolving physical and transition risks that could significantly impact their business models and solvency.

In alignment with the third strategy of the Paris Agreement, the EU introduced its first legislative act on sustainability specifically targeting the financial sector, including insurers: Regulation (EU) 2019/2088, also known as the Sustainable Finance Disclosure Regulation (SFDR). This regulation targets investment and financial market products, including insurance based investments. 

Large public companies are required to report on certain ESG aspects (e.g. climate change, human rights, anticorruption, gender equality) starting in 2018 under Directive 2014/95/EU, the Non-Financial Reporting Directive (NFRD).

In 2025, many entities, will obligatory report for the first time on sustainability-related issues for the fiscal year 2024. This requirement stems from Directive (EU) 2022/2664, known as the Corporate Sustainability Reporting Directive (CSRD), and Regulation (EU) 2023/2772, which established the first set of reporting standards, the European Sustainability Reporting Standards (ESRS).

CSRD and ESRS are pivotal in advancing sustainability at the microeconomic level, as increased reporting is expected to heighten awareness of sustainability issues and foster mitigation and adaptation measures. The most comprehensive of these standards is ESRS-E1, which focuses on climate change reporting. 

The timeline below illustrates the publication dates of major legislative acts related to sustainability and the insurance sector. Notably, this regulatory activity has intensified in the last five years, driven by greenhouse gas emission reduction targets.

The timeline below illustrates the publication dates of major legislative acts related to sustainability and the insurance sector. Notably, this regulatory activity has intensified in the last five years, driven by greenhouse gas emission reduction targets.

Looking ahead, additional ESRS tailored to specific economic sectors will be introduced. 

Large public companies should also consider the International Sustainability Standards Board’s (ISSB) IFRS Sustainability Standards. While these standards complement the ESRS, their focus lies on disclosing sustainability information relevant to the interests of investors and financial market participants.

The next figure summarizes the sustainability-related texts relevant for the insurer. The ISSB standards are not yet obligatory. 

While compliance with ESRS-E1 is mandatory, climate-related sections in the ORSA will only be monitored by the relevant authorities.

However, ESRS-E1 and EIOPA-BoS-21-127 differ fundamentally in perspective:

• ESRS-E1 emphasizes the material impact of the company’s operations on climate change.

• EIOPA-BoS-21-127 focuses on how climate change risks (both physical and transitional) translate into traditional prudential risks such as underwriting, market, credit, operational, and reputational risks.