Taking sustainability risks into account in the supervision of insurance undertakings: regulatory changes and expectations set by supervisors
On 21 April 2021, the European Commission adopted its proposal on amending the Solvency II Delegated Regulation (EU) 2015/35 as regards the integration of sustainability risks in the governance of insurance undertakings. These changes are expected to become applicable in autumn 2022. In addition, the European Insurance and Occupational Pensions Authority (EIOPA) published on 19 April 2021 an opinion, directed at national supervisors, on the use of climate change risk scenarios in insurance undertakings’ management of sustainability risks.
The Solvency II amendments concern the integration of sustainability factors in risk management, the risk management function, the actuarial function, remuneration policy and the application of the prudent person principle. Sustainability risks have not earlier been specifically mentioned in the regulations, but previously insurance undertakings have had to assess and take into account all material risks in their operations. In the future, sustainability risks must be assessed, a materiality assessment made for them and the results of the assessment documented. If an insurance undertaking does not consider sustainability risks to be material to its own operations, it must be able to justify this.
In supervising sustainability risks, the Financial Supervisory Authority (FIN-FSA) applies both the SIF/IAIS Application Paper on the Supervision of Climate-Related Risks in the Insurance Sector and the above-mentioned EIOPA opinion on climate scenarios. The supervision will cover, for example, good governance, risk management, investment activities and reporting. The principle of proportionality shall apply in supervision.
An insurance undertaking’s own risk and solvency assessment (ORSA) is based on a deep understanding of the undertaking’s own business model and the identification of business risks and the factors underlying them. It acts as a link between the company’s strategy and business operations and the assessment of solvency needs. The ORSA must also assess material risks outside the scope of solvency regulations, such as changes in investment and insurance activities caused by sustainability factors. With regard to the use of climate scenarios, the FIN-FSA recommends the rapid introduction of at least a qualitative assessment method, and later also a quantitative analysis for material risks as part of the ORSA.
The time horizon used in the scenarios should be sufficiently forward-looking, up to decades ahead. Climate scenarios should be sufficiently comprehensive and include at least two different temperature increase pathways: a pathway in line with the goals of the Paris Climate Agreement and a climate change risk scenario where the global temperature increase clearly exceeds 2°C. Due to the uncertainties associated with long-term scenarios, they do not need to be updated annually and the use of significant simplifications is also possible. Methods of analysis should, however, evolve over time.
For further information, please contact
Mikko Sinersalo, Senior Risk Specialist, tel. +358 9 183 5542 or mikko.sinersalo(at)fiva.fi