Introduction

It has been a long time since green was just a colour. Green is a quality claimed by several different groups, from political parties, to vegetarians and vegans, to hunters. So it is hardly surprising that “green” does not mean the same thing to everyone.
The same is true for sustainability. Anybody who even as much as follows the societal discussion about it from the sidelines develops an abstract notion of what sustainability means. But while it is not a huge issue when private individuals talk past each other in conversations about the topic, supervisory authorities need to develop a shared understanding of sustainability, as they need a common premise on which to base their examination of whether companies are acting sustainably.

The “E” in ESG has always been an inherent part of insurers’ DNA

Take anything more than a brief foray into the field of sustainability and you will quickly come across the acronym ESG, which stands for environmental, social and governance. Coming to grips with the “E” in ESG has always been an inherent part of the DNA of insurers that cover the financial losses caused by weather-related events and are in direct contact with claimants. Reinsurers have the global outlook they need for perils resulting from climate change, and have built up many years of expertise.

As risk carriers and risk managers, insurers play key roles in the economy. Before concluding a contract they examine whether the measures taken to mitigate risk are sufficient and, if necessary, call on the proposer to put in place further precautionary measures so that the risk can be insured.
When a loss occurs, insurers pay the costs that arise, such as the necessary restoration costs for a building hit by flood damage. There are also insurance products to cover damage to the environment. In all cases, insurers contribute to reducing the damage for society.

This means that insurance undertakings are the first points of contact for the real economy when it comes to dealing with environmental risks. This core competence is a chance for them to make their mark on the societal debate and is an asset that the industry should make the most of.
The sustainability of society’s future behaviour from an environmental perspective will be reflected in the frequency and amount of claims payments. If – as the majority of scientists believe – climate change increases the likelihood of typical insured perils such as storms, fires and floods, it is very much in insurers’ own interests to be involved in the fight against climate change.

Insurance undertakings are able to quickly free themselves from their contracts, which, as a rule, only have a duration of one year, and can therefore counteract the danger of incalculable claims expenditures. However, in the medium to long term the business model itself is on the line: it is doubtful whether insurers would still be able to offer sufficient and affordable coverage if the global temperature rose to three degrees above its level before industrialisation.

If existential risks can no longer be insured, this will have serious consequences for the real economy. But the insurance industry would also be directly affected if its premium income in property lines of insurance were to decrease in volume.

BaFin expects the insurance industry to actively address all relevant environmental risks in their risk management and to keep an eye on the effects these have on their business models. Insurers should sharpen their focus as risk managers, keeping in mind potential future developments and applying their expertise in the societal debates. Against this backdrop, I welcome the current position taken by the CRO Forum¹ in the paper titled “The heat is on”.²

ESG issues in investments come to the fore

Another, more recent task for the insurance industry as a whole is to deal with ESG-related issues in investment policies, although a number of insurers have already been working on this topic specifically for some time.

Insurance undertakings are some of the largest institutional investors. German life insurers and Pensionskassen alone hold investments with a book value of over a trillion euros that can be invested long-term. It is therefore understandable that certain groups of stakeholders see the insurance industry as a potential source of financing for the sustainable restructuring of the economy.

However, investments for insurance undertakings are primarily assets to cover their obligations on the liabilities side, which in many cases are long-term in duration. Life insurers and Pensionskassen meet their obligations over several decades; in some cases, benefits are only paid after 60 years. This means that the assets need long-term availability and need to remain stable in value. From this perspective, insurers are, by definition, already acting sustainably.

When the European Commission presented its Action Plan for a greener and cleaner economy in 2018, it called for further action from the finance industry³ and, shortly afterwards, produced draft legislation regarding climate benchmarks, a classification system (taxonomy) and transparency in investments. BaFin expects that spring 2019 will bring, among other things, the adoption of a European regulation on disclosures relating to sustainable investments and sustainability risks.⁴

Moreover, the European Commission has called on the financial industry to help finance measures to achieve the objectives of the Paris Agreement⁵. At present, there is no legal obligation for insurers to play a role in financing Germany’s energy transition or other large-scale projects.
BaFin is being guided by the principle that no regulatory bonuses can be granted for sustainable investments if such a bonus is not justified with regard to the underlying risks – unless it is found that the investments are associated with lower risks. Ultimately, the risk of default is present in all forms of investments. This risk is appropriately included in the standard formula for the calculation of own funds under the European supervisory regime Solvency II.

Anyone contemplating capital relief needs to ask themselves the following questions at the very least: are the sustainable investments really lower risk? Have new risks – political risks, for example – been taken into account appropriately?
Sustainability involves – as stated above – taking a long-term approach. Insurers will only make long-term investments if they can cover corresponding long-term liabilities. For the insurance industry to provide a substantial contribution, it is therefore of key importance that insurers remain willing to take on long-term illiquid liabilities in the future.

Regulation and sustainable investment

From the regulatory perspective, sustainability in investment policy is far from a new issue. The European Insurance and Occupational Pensions Authority (EIOPA) outlined certain expectations back when it introduced Solvency II. The EIOPA Guidelines on the system of governance, for example, make it clear that sustainability is one of the aspects to be considered when investing under the prudent person principle⁶.

With effect from the start of this year, the German Insurance Supervision Act (Versicherungsaufsichtsgesetz – VAG) specifies, with regard to investment, the extent to which institutions for occupational retirement provision (IORPs) are to address ESG issues in their system of governance, for example in risk management and in the Own Risk Assessment (ORA)⁷. IORPs are required to be transparent to the public, supervisors and customers about whether and how they take ESG issues into account in their investment policies.

At European level, EIOPA emphasises the relevance of the issue from a supervisory point of view and plays a role in shaping the regulatory requirements. A project group has been set up for this, and BaFin is directly involved in the work of this group. EIOPA is thereby taking into consideration both investment risks and the risks that exist in connection with the underwriting of insurance contracts.

This will be reflected in its response to the European Commission, which it will submit as part of its technical advice⁸ on Solvency II and on the Insurance Distribution Directive (IDD) on 30 April 2019. The focus will be on insurers’ systems of governance and the inclusion of ESG factors when determining the target market. In EIOPA’s interpretation, it is not just the risk management function that should address ESG risks, but also the actuarial function, for example. EIOPA’s suggestion to amend certain points in the regulation underwent a public consultation at the start of this year. BaFin is in support of the chosen approach and is closely following how the European Commission sets out the delegated acts on Solvency II and the IDD on the basis of EIOPA’s technical advice.

However, EIOPA’s project plan for 2019 envisages a large number of other activities connected to sustainability. As early as summer 2019 EIOPA is planning to provide, in an EIOPA Opinion targeted at national supervisory authorities, specific details on how IORPs are to handle ESG risks in their system of governance. BaFin will provide its input on this in the Board of Supervisors. In addition, the European Commission has asked EIOPA for a response (Request for an Opinion) to more quantitative questions (Pillar I under Solvency II). EIOPA is currently carrying out comprehensive analyses to this end, taking into account the findings of a survey it carried out recently in the insurance industry. EIOPA will respond to the European Commission’s enquiry by 30 September 2019.

Transparency is also a topic of focus at present for the Sustainable Insurance Forum (SIF)⁹, which is a global network convened by the United Nations Environment Programme that BaFin has been a member of since its inception. Since 2018, EIOPA has also been a member of this network . Supervisors use this regulatory platform to share experiences or conduct joint research. Since the SIF, in collaboration with the International Association of Insurance Supervisors (IAIS), published the “Issues Paper on Climate Change Risks to the Insurance Sector”¹⁰ last year, it has been reviewing how insurance undertakings are implementing the recommendations of the FSB Task Force on Climate-related Financial Disclosures¹¹. In order to research this, SIF members are currently conducting a randomised survey among the insurance undertakings under their supervision. The SIF hopes to present its findings this year.

Sustainability in investments a key focus for BaFin

For 2018 and 2019, BaFin’s insurance supervision sector named sustainability in investments as one of its supervisory priorities. Linked to this, specific activities and events were organised at national level, such as supervisory discussions with insurance undertakings, surveys and industry workshops. Last year, for example, BaFin conducted an industry survey, which turned out to be very informative. It indicated that insurers considered 73 percent of their investments to be sustainable – although this was on the basis of their own interpretation of the concept.¹² Almost half of the companies surveyed stated that they used a negative list, which is a list of investments that do not meet certain criteria and which therefore cannot be invested in. Meanwhile, only 13 percent of insurers use a positive list to record which investments may be deemed sustainable.

The workshops BaFin held with the industry also provided important insights into insurers’ approaches to ESG risks in their investment policies. The workshop format proved valuable, and BaFin therefore intends to continue it in 2019. The goal of these various initiatives is to support the transfer of knowledge across the entire industry and to improve insurance undertakings’ awareness of the need to include ESG risks in their system of governance and to organise their internal processes accordingly. To this end, BaFin will release a guidance notice for all financial sectors to communicate its opinion. It will provide an initial outline for this at the conference it is hosting on 9 May 2019¹³ regarding sustainability in the financial sector¹⁴.

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