Report – Transition Planning for Insurers: A supervisory tool to improve climate risk resilience | Finance Watch

Report – Transition Planning for Insurers: A supervisory tool to improve climate risk resilience

11 April 2024


As climate chaos seals the fate of usual economic models in the insurance sector, transition plans are poised to become lifelines for insurers and for the whole economy. This report highlights the most critical aspects to turn transition planning into a powerful tool for insurers to mitigate transition and physical risks and play their part in the transition.

From driver of resilience to destabiliser

The insurance sector—traditionally a driving force of resilience for the economy—now propels economic destabilisation by operating without considering the impact of their activities on climate change, exposing itself to unaccounted transition risk while transferring the snowballing financial burden of climate-related impacts to the end consumer and taxpayerTo manage the size of rising insurance claim payouts, insurers apply risk mitigation strategies—such as premium increases, mitigation-linked discounts, coverage exclusions, catastrophe (CAT) bonds—and call for private-public partnerships sharing in the increasing risks. However, these measures often transfer the financial burden to policyholders, investors, and taxpayers.

Plans for an orderly transition

A consensus among supervisors and regulators has emerged: an orderly and timely transition is crucial to successfully guiding the economy through the climate crisis. Insurers have therefore been required to plan for a transition to net-zero as systemic actors subjected to the risk management requirements and prudent person principle under Solvency II. As key actors of the economy, they are also subjected to the due diligence obligations and transition plan requirements in alignment with the EU climate law under the CSDDD.

Insurers at a crossroads

If insurers carry on their business-as-usual prioritising short-term profitability, climate change will eventually lead to an economic reality in which the insurance sector can no longer function. Mitigating the devastating effects of climate change and of a disorderly transition are key responsibilities and in line with the risk management role of the insurance sector. 

Stewards of the transition

As transition planning establishes itself as a strategic tool, EU regulators have an opportunity to go beyond a narrow view on the balance sheet-related risks to create a supervisory tool that can redefine the role of insurance in the transition and strengthen the supervisory toolkit to deal with sustainability risks. With their vast resources as asset ownersAs investors, insurers should actively engage with their investee counterparties to drive substantial real-economy impacts towards sustainability. This involves leveraging disclosed transition plans for making informed investment decisions that support broader transition efforts and climate solutions. Insurers should also employ strategies such as issuing public statements, sending letters to boards, openly communicating voting intentions, tabling voting resolutions, and fully utilizing their voting rights to advocate for sustainability-related decisions. These actions must be guided by a clear voting policy to ensure consistent support for the transition to a sustainable economy., and as indispensable facilitators of economic activities through underwritingAs underwriters, insurers engage with their underwriting counterparts by utilizing disclosed transition plans to offer risk-adjusted insurance, thereby supporting broader transition efforts and climate solutions. This engagement should extend to implementing underwriting covenants aimed at promoting both mitigation and adaptation efforts within the context of sustainability. Additionally, insurers must establish clear escalation procedures, which may lead up to and include the termination of contracts, to ensure compliance with sustainability criteria and to encourage responsible environmental stewardship., insurers can catalyse transformations, innovations, foster collaborations, and shape industry standards.

A supervisory tool for climate resilience

This report highlights some of the most critical aspects that will shape transition planning for insurers: target setting, corporate governance, focus on whole-economy transition, engagement, use of underwriting covenants to promote transition efforts and transparency. We also discuss the role supervisors can and should play in both guiding and monitoring the path to success as part of their prudential mandates. Please contact the author for more information.

Key recommendations

  1. Prioritise tangible, real-world impact for the insurers’ asset and liability portfolios by incorporating all Scope 3 emissions, including underwriting, and focusing on the reduction of GHG emissions in absolute terms.
  2. Formulate transparent investment and underwriting policies that encompass engagement procedures and are subject to identifiable milestones against which progress can be measured, alongside short (1–3 years), medium (3–5 years), and long term (5–10 years and beyond) targets. 
  3. Utilise all possible counterparty engagement tools to meet sustainability-related targets in investee and client (underwriting) practices and relationships. 
  4. Institute comprehensive governance by assigning accountability for the transition plan to senior management, identifying and developing necessary skills and linking a meaningful percentage of the remuneration plan to achieving transition goals, including using deferred remuneration and clawback mechanisms. 
  5. Establish robust prudential supervision by integrating transition planning into the supervisory review process, extending the definition of the long-term view beyond the usual time frames by considering sustainability-related impact mitigation as a means to ensure financial stability. 

Under Solvency II mandate, EIOPA has 18 months to write transition plan guidance and consult the public on their work. We would want EIOPA to get inspiration from this report for their first draft, as well as push the topic with other relevant bodies such as the IAIS.

Finance Watch is facilitating a civil society informal working group on transition plans, which will contribute to the next initiatives from EIOPA, EBA and IAIS.

Please reach out if you want to be involved.

Read also our press release