When Ursula von der Leyen, President of the EU Commission, muses about the future, her thoughts invariably turn to the environment: “I want Europe to go further still and become the first climate-neutral continent.” Jörg Asmussen echoes this sentiment. “We will become greener”, says Asmussen, designated Chairman of the Management Board at the German Insurance Association (GDV). By “we” he means the insurance sector. In fact, the future of Europe is closely intertwined with the future of insurance.
Ms von der Leyen’s Green Deal represents a sea change covering all economic sectors. Making Europe the first climate-neutral continent by 2050 requires a total overhaul of energy supply, industry, transport and agriculture: moving away from fossil fuels and environmental pollution in favour of sustainability and climate protection. And the impact is not restricted to the real economy. The financial markets and capital flows will also have to be realigned.
Green Deal costs 1 Trillion Euro
The ambition of this plan is reflected in the level of cost involved. The EU Commission aims to mobilise in the region of EUR 1 trillion to the Green Deal over the next ten years. EUR 500 billion are planned to come out of the EU budget that was approved a few weeks ago. Then there is national funding and special support measures for the most affected regions. “Public sector funding will not be enough, though”, asserts von der Leyen. She wants to add private financing to her project of the century, ideally to the tune of EUR 280 billion.
Insurance would seem to be the ideal partner for this venture: “Insurers play a key role in the economy, as risk bearers and as long-term investors”, underlines Asmussen. In both these capacities, insurance companies can make a material contribution to Europe’s Green Deal. The investment portfolio of direct insurers alone comes to about EUR 1.5 trillion, and many of them already take sustainability criteria into account when making new investments, including environmental, social and governance (ESG) factors. It’s in their own interests. Global warming poses a long-term threat to the insurance business model. If natural disaster losses were to become excessive, climate risks would ultimately become uninsurable. “We should do more and we will do more”, is how Asmussen expresses the industry’s readiness to act.
EU Commission aims to incorporate sustainability aspects into Solvency II
This complements the developments at a political and supervisory level. The current Solvency II (the European insurance supervisory regime) review shows that. The EU Commission aims to incorporate sustainability aspects into the pending regulatory framework review for the first time. That would lead to insurers including climate risks in their underwriting policy. As a result, insurers could work with their clients in future to develop sustainable growth strategies together. Insurers would become eco patrons, if you will. They must also align their risk management and investment more closely with environmental factors.
That is contingent on the right incentives being in place, as Asmussen points out. With regard to Solvency II, the priority is not to further complicate long-term investments. A lot depends, for example, on how the long-term interest rate is modelled in future, which life insurers use to value their liabilities. It is inversely proportionate to reserving requirements (the lower the interest, the higher the reserves). A lower interest rate thus leads to less equity for investments, including sustainable ones.
Germany's insurance companies against green supporting factors
Insurers would also like to see a more effective volatility adjustment, allowing them to cushion short-term fluctuations in their solvency balance sheet. As long-term investors – with an investment horizon of 20 years or more – they are well equipped to see out financial market excesses. Practically no other investor group can say the same. This very long-term perspective makes life insurers ideal partners for the ecological revolution. Sustainable infrastructure and energy projects tend to be long-term in nature and often not as liquid as other asset classes.
However, the insurance sector is opposed to a flat-rate discount for green investments, for example in the form of a lower capital requirement: “That would go against the risk-based approach of Solvency II“, argues Asmussen. The Federal Financial Supervisory Authority BaFin concurs. “It would pave the way to the next crisis and harm sustainability”, warns BaFin President Felix Hufeld. The downfall of German solar manufacturers reminds us that not even “clean” industries are immune to risk.
Solvency II review will take at least until 2023
Nonetheless, the EU Commission is considering capitalisation discounts as a tool for green investments. “It’s something we're thinking about and we will evaluate closely”, says Didier Millerot, who is in charge of insurance at the Commission. They are aware that such a measure is controversial, but Millerot is unmoved. “If you want change, you may have to take certain steps to make it happen.”
However, it is not a done deal, yet: first of all, the European insurance supervisory authority Eiopa will submit its recommendations for the Solvency II reform to the Commission by the end of the year. The EU Commission will then work out a legislative proposal, which needs to be approved by the European Parliament and Council. As things currently stand, the new supervisory law will come into effect by 2023 at the earliest.
Common environmental classification system is needed
The EU Commission still has many other tasks on its to-do list. For example, there is the classification of sustainable investments, known as taxonomy. In order for insurers to expand their commitment to sustainable investments that they will have to report in future, they need to know exactly what counts as sustainable investments. Clear-cut criteria are needed, as with the classification of foodstuffs.
This work has started. However, to date criteria have only been set for two of the six environmental objectives – climate change mitigation and climate change adaptation – and even then only for certain sectors. Granted, those sectors do account for most of the CO2 emissions, but they only represent just under half of gross value added. The EU Commission doesn’t plan to present proposals for applying the taxonomy to the other economic sectors before the end of 2021. Moreover, it will probably take another year to define the details of the four other environmental objectives, for example protection of ecosystems or the transition to a circular economy.
Social and governance factors will be considered later
There is no sign of guidelines for social or governance goals. “For now, we are only interested in the “E” of ESG”, says Asmussen. The delay is troublesome to insurers. That is why Asmussen wants to inject some urgency and advocates an unbureaucratic solution, which could turn into an international standard in the long term. Ultimately, the finance flows are global. “Asian investors are looking very closely at how Europe applies the ESG criteria.”
To date, investors have encountered many hurdles, even within Europe: “We have plenty of funds. However, what we don't have is a single financial market”, laments Sylvie Goulard, Deputy Governor of the Banque de France. Differing insolvency regulations and creditor rights plus an inconsistent data pool for financial and non-financial key performance indicators also continue to hinder the monetary flow within Europe. A deepening of the internal capital market could have a big impact: it would facilitate cross-border investments, medium-size companies would receive new funding sources apart from banks and more capital providers would also be ready to invest in long-term infrastructure and environmental projects. Completion of the capital markets union therefore needs to be accelerated, asserts Goulard.
Capital Markets Union should support recovery
The coronavirus crisis could be the catalyst for that. EU Commission Executive Vice President Valdis Dombrovskis has called the capital markets union a key project for kickstarting the European economy. “The capital markets union can initiate change, provided we make significant progress now.” At the start of June, a group of high-ranking experts submitted proposals following six months of work, including a harmonisation of insolvency law. Dombrovskis aims to present his own proposals for the next action plan by early autumn.
Deepening the capital market would significantly expand investment opportunities for German insurers. The paucity of suitable projects has been another obstacle preventing insurers from increasing their stake in sustainability. The sector hopes the planned expansion of pan-European emissions trading will provide a boost: if the business sector has clarity regarding the timeframe and value of carbon dioxide pricing, it will have planning security for investments in emission-cutting projects. Von der Leyen has already promised to make emissions trading more expensive for aviation and to expand it to shipping, road traffic and construction.
Leaving no one behind could also be interpreted as a nod to the insurance sector
The EU plans to establish a new project platform to mobilise private capital and offer consulting services to project developers and investors, as it did with the Juncker plan to mitigate the fallout from the financial crisis. Public guarantees also proved effective at that time. The European Investment Bank offered a carrot to private investors by assuming a portion of the default risk.
That would be another good method of encouraging insurers to pursue green investments now. Initiatives could also be clustered into funds to make smaller, communal projects appealing to major investors. This saves costs and would support small insurers in particular, who don’t have sufficient resources to manage many individual projects.
Remember what von der Leyen said when announcing her Green Deal? No-one is to be left behind in the European transformation. That was a message to those regions and sectors most affected by the upheaval. It could also be interpreted as a nod to the insurance sector.