EIOPA’s fossil fuel shakeup: are insurers rethinking their investment strategies?

EIOPA, the European Insurance and Occupational Pensions Authority, has recommended additional capital requirements for fossil fuel assets on insurers’ balance sheets, arguing that transition risks are not currently being accurately priced in.

In a discussion paper published last month, the regulatory body for the European pensions and insurance industry suggests raising capital requirements for investments in fossil fuel shares to 17% and for equities by up to 40%. In other words, it could soon become significantly more burdensome for insurers to hold these assets on their balance sheets.

Under Solvency II, the regulatory framework governing the European insurance sector, insurers and reinsurers are required to hold a certain amount of liquid assets to cover potential losses in a given year.

EIOPA’s changing approach to fossil fuel assets assumes that they face higher levels of exposure to transition risks, which are not yet adequately reflected in current pricing.

The move has been welcomed by climate campaigners, who see it as a clear message to insurers to review their exposure to fossil fuels. “The insurance industry has an opportunity to catalyse the equitable, clean energy transition for communities, families, and workers. By doing so, insurers will mitigate catastrophic losses by reducing pollution, while unlocking the financial benefits from renewable energy insurance that is expected to generate cumulative premiums of $237 billion by 2035,” argues Minyoung Shin, programme director for insurance at the environmental non-profit, The Sunrise Project.

But will EIOPA’s proposals have a tangible impact on insurers’ asset allocation? So far, climate campaigners have tended to focus on insurers’ underwriting activities in supporting fossil fuels, while paying relatively little attention to their investment portfolios.

If rating agencies are to be believed, the impact of EIOPA’s new guidance could be marginal, due to limited exposure to fossil fuel assets. A recent briefing note by Fitch Ratings suggests that the proposed surcharges would have a limited impact on Solvency II (S2) ratios. Fitch predicts the changes would affect insurers in the Nordics and France most strongly, as countries such as Norway and Sweden have relatively higher exposures to fossil fuel assets, whereas other major insurance markets, such as Germany, have minimal exposure.

However, MSCI’s Anja Ludzuweit, executive director and research lead for climate policy solutions, takes a different stance: “We already see insurance clients evaluating climate-related risks according to EIOPA's application guidance, particularly through climate scenario analysis in their ORSA processes. This approach aligns with EIOPA's study on the prudential treatment of sustainability risks, especially its forward-looking analysis of equities and bonds,” she explains.

She highlights that consistent multi-horizon climate scenario analysis and location-based stress testing tools will become increasingly important for investors aiming to capture transition risks in their portfolios. However, Ludzuweit cautions against simply divesting from fossil fuel assets: “We see exclusion strategies as problematic due to higher tracking errors and potential liquidity risks.”

EIOPA’s proposals are currently under review by the European Commission, which has the authority to turn them into binding legislation.

Impact across the Channel
While Britain’s insurers are not directly impacted by the proposals, Anand Rajagopal, private markets sustainability lead at the Phoenix Group’s asset management division, acknowledges the potential signalling power of EIOPA’s recommendations:

"The UK PRA has already noted that all insurers, as part of their Matching Adjustment (MA) attestation, may need to factor in climate risk within their overall investment process. Specifically, the PRA set out in CP19/23 that as part of the attestation process, firms will need to consider the extent to which the Fundamental Spread is sufficient compensation for all retained risks, including environmental risks related to climate change,” he explains, adding that climate risk add-ons to the Fundamental Spread are under consideration.

“While there has been further regulatory change here in PS10/24, the point still holds that firms may wish to consider climate risks in relation to the Fundamental Spread and the overall Matching Adjustment attestation,” he cautions.

Ultimately, EIOPA’s proposals are likely to influence insurers’ investment behaviour, he predicts: “If the capital charges are increasing, you are potentially being disincentivised from investing heavily in the sector. That is the potential first-order impact. A second-order impact is that you are much less likely to finance those activities unless you see positive changes in sector or issuer behaviour through engagement or stewardship efforts. Otherwise, you may even reconsider your decision to remain invested.”