EIOPA recommends a dedicated prudential treatment for insurers’ fossil fuel assets to cushion against transition risks

The European Insurance and Occupational Pensions Authority (EIOPA) published today its final Report on the prudential treatment of sustainability risks within Solvency II, recommending additional capital requirements for fossil fuel assets on European insurers' balance sheets to accurately reflect the high risks of these assets. The report follows a mandate given to EIOPA by the European Commission to assess the potential for a dedicated prudential treatment of assets and activities associated with environmental or social objectives or those that harm such objectives.

The report's findings are based on a risk-based analysis of data and evidence, and take into account the feedback received from stakeholders on EIOPA's Discussion Paper on methodologies and data sources as well as during a public consultation on preliminary findings and policy proposals. The report covers three distinct areas: the market risk of assets exposed to the climate transition, the impact of climate risk-related prevention measures on non-life underwriting risks and the treatment of social risks.

Market risk of stocks and bonds exposed to the transition

EIOPA's backward and forward-looking analysis of equity and spread risks demonstrates that fossil fuel-related stocks and bonds are more exposed to transition risks than assets connected to other economic activities. To ensure that European insurers set aside enough capital to withstand potential losses from investments in assets with high transition risks, EIOPA is recommending additional capital charges for these assets. This approach would better align capital requirements with insurers' actual risk exposures.

For stocks, EIOPA proposes raising capital requirements by up to 17% in additive terms on top of the current capital charge, leading to a moderate increase in insurers' capital requirements. An impact assessment has shown that such a surcharge would have a limited impact on undertakings' solvency ratio given their relatively low exposure to directly held fossil fuel stocks.

For bonds, EIOPA recommends a capital charge of up to 40% in multiplicative terms in addition to existing capital requirements, instead of introducing no change at all or applying rating downgrades to fossil fuel-related bonds. The capital surcharge option is considered to better reflect the high risk profile of these bonds while preserving the risk-sensitive design of the Solvency II standard formula for spread risk.

Adaptation measures in non-life underwriting

In this area, EIOPA analysed to what extent preventive, climate-related adaptation measures that policyholders can implement directly (e.g. installation of anti-flood doors or fire-proof vegetation around properties) may lower insurers' underwriting risks. While the findings do indicate a potential reduction, EIOPA proposes to repeat the analysis in the future once higher quality data is available that would allow the authority to draw more robust conclusions.

Social risks

EIOPA is convinced that all aspects of sustainability risks, including social risks, deserve equal attention, also from a prudential perspective in the context of the double materiality principle.

This report examines how social risks can translate into prudential risks on insurers' balance sheets and outlines future efforts to develop application guidance to help insurers assess social risk materiality as part of their Own Risk and Solvency Assessment (ORSA). Due to the current lack of data and risk models, EIOPA does not recommend a specific prudential treatment of social risks at this stage.

Go to the Report

Next steps

EIOPA has submitted its recommendations to the European Commission, advising it to thoroughly consider the proposals within the broader context of sustainability regulation, including cross-sectoral consistency, potential impacts on transition efforts, and possible evolution of relevant regulatory frameworks. The Commission will review the report and consider implementing the proposed additional capital requirements for fossil fuel assets.