Dr Frank Grund sums it up: "Sustainability is one of the major issues of our times, for insurers too." The BaFin Chief Executive Director remarked that they were surveyed both as investors and also specifically as risk carriers. The issue affects both the assets and liabilities sides of their balance sheets, and they are mainly concerned with finding the right way to manage sustainability risks. Grund thinks they are on the right track, but there is still a long way to go.

This was the outcome of a BaFin survey on the issue. BaFin wanted to find out in detail how insurers and pension funds handle sustainability risks and how they have implemented BaFin's Guidance Notice on Dealing with Sustainability Risks. It had previously surveyed other entities under its supervision back in spring 2021, but there were far more questions for insurers and pension funds to answer (see info box).

Environment, social and governance (ESG) factors

A welcome outcome of the survey is that the insurance sector – like the financial sector as a whole – is largely already aware of the topic of sustainability. The vast majority of respondents even went as far as to factor in sustainability aspects in their entirety – in other words not just the physical and transition risks of climate change that so often feature in the media, but also social and governance factors (see Fig. 1). These are frequently grouped together under the acronym ESG: environment, social, governance.

Fig. 1: If insurers or pension funds do address sustainability risks, what does this cover?

© BaFin

Source: BaFin

The entities' primary motivation is to identify and monitor sustainability risks (98%) and to avoid reputational damage (96%). On a positive note, more than three-quarters of the insurers and pension funds also want to make specific use of the opportunities arising as the economy shifts towards sustainability, and favour actively managing sustainability risks.

Risk sensitivity: relevance and materiality of sustainability risks

A clear majority of the insurers and pension funds taking part in the survey assume that sustainability risks generally impact all other known risk categories. 93% reckon with effects on market or investment risk, while 88% see consequences for reputational risk. Interestingly, a far smaller number rate this impact as material. Reputational risk and market/investment risk are the only categories where around half of respondents expected material effects.

When asked which lines of business and risk exposures are particularly affected by sustainability risks, the most frequent example cited was investments. This is logical given the assessment of market risk. Where the three ESG factors are concerned, the dominant impact is from climate risks. To date, only a small number of insurers and pension funds expect that sustainability risks will have significant effects on the liabilities side of the balance sheet, in other words on their product and underwriting policies.

Modifying business and risk strategies

Roughly half of the entities surveyed have already reviewed and modified their business and risk strategies to reflect sustainability risks. However, a number of insurers and pension funds have only now begun to launch such projects or are still in the implementation phase.

The precise strategic measures cited by the insurers and pension funds include defining specific sustainability targets and aligning their business activities with political goals. This covers somewhat more than half of responses. Roughly one third focus on targeted "active ownership" or set special requirements for customers/third parties. While completely discontinuing lines of business remains the exception (16%), 30% of entities anticipate having to cut back on certain lines of business.

Responsibility within the entity

The management board as a whole is responsible for setting the business and risk strategy and for communicating and implementing it in the entity. Other business units may also be involved in its operational implementation.

BaFin therefore welcomes the survey outcome that 92% of insurers and pension funds allocate responsibility for handling sustainability risks to the management as a whole. Roughly one-third assign an additional area of responsibility to the chief risk officer, chief executive officer or chief financial officer.

System of governance

Insurers and pension funds believe that sustainability risks are highly relevant to investments, and these risks are therefore already well integrated into internal policies (75%) and the respective processes (77%). More than half of respondents have also modified their risk management policies and processes accordingly.

At 86% of the entities, responsibility for managing sustainability risks lies with operating units such as the front desk, front office or portfolio management, while 59% assign such a role to the independent risk management function.
Risk management

The majority of the insurers and pension funds surveyed have already defined tasks, responsibilities and a timeframe to enable them to identify, assess, manage, monitor and report on sustainability risks.
As in the assessment of sensitivity to sustainability risks (relevance and materiality), market /investment risk and reputational risk are the key concerns for risk management (see Fig. 2).

Fig. 2: In what areas of risk management do insurers or pension funds take sustainability risks into account?

© BaFin

To date, more than three-quarters of entities have used expert judgement as the basis for assessing sustainability risks. Quantitative methods remain the exception, since most entities lack the requisite underlying data.
Stress testing and scenario analyses

Surprisingly, less than one-quarter of entities are already employing sustainability-related stress tests and scenario analyses. Less than half of respondents stated that they were at least preparing such stress tests (see Fig. 3).

Fig. 3: Does the insurer or pension fund conduct stress testing/scenario analyses in relation to sustainability risks? If yes, for what purpose?

© BaFin

With only a small percentage of insurers already employing sustainability-related stress testing, there were very few responses to the detailed questions about the type and scope of scenarios and assumptions used. This means that it is not possible to make representative statements.

There is an astonishing discrepancy between the widespread awareness of how important climate-related risks are and the small number of stress tests carried out.

Outlook

The results of the survey confirm that sustainability risks have gained a foothold in the strategic thinking, business organisation and risk management of insurers and pension funds.

Nevertheless, there is some urgent catching-up to do on the use of internal stress tests and scenario analyses, particularly given that as early as this year BaFin expects insurance undertakings falling within the scope of Solvency II to provide climate-related scenario analyses as part of the own risk and solvency assessment (ORSA) if those risks are material for them.

"We expect the insurers under our supervision to make up the lost ground quickly," said Chief Executive Director Dr Frank Grund. BaFin's Insurance and Pension Funds Supervision Sector will thus continue to focus on sustainability in 2022, keeping a close eye on further developments at individual entities and, where necessary, ramping up its supervisory activities.