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12 August 2021 Supervision Supervision label Q&A

Question:

Does DNB expect Dutch insurers to take climate-related risks into account?

Answer:

Yes Article 262 of the Commission Delegated Solvency II Regulation (EU) 2015/35 stipulates that an insurer's Own Risk and Solvency Assessment (ORSA) must be forward-looking and include: “the risks the undertaking is or could be exposed to, taking into account potential future changes in its risk profile due to the undertaking's business strategy or the economic and financial environment, including operational risks.”

Guideline 5 of the framework also states that ‘The undertaking should evidence and document each ORSA and its outcome’. Given the potential impact on the asset side of their balance sheets as well as on their technical provisions, we expect insurers to integrate climate-related risks into their Own Risk and Solvency Assessments (ORSA) by analysing and describing the influence of these risks on their risk profile. We expect the ORSA report to present and explain the outcomes of this analysis in the ORSA report. If climate-related risks are not regarded as material, for instance because the insurer is not or could not be exposed to them, then we expect this to be included in the explanation.

Climate-related risks for the insurance sector can be divided into physical risks and risks ensuing from the transition to a climate-neutral economy. Both risks may materialise as financial risks and hence have an impact on insurers. In cross-sectoral terms, both physical risks and transition risks may materialise on the asset side of an insurer's balance sheet, regardless of the nature of the institution's activities.

  • Exposures are vulnerable to the physical consequences of changing weather. Examples could include damage to collateral such as real estate, or a write-down of companies whose property or processes are exposed to physical consequences of climate change (physical risk).
  • A new climate policy (involving increasing government regulation and stricter standardisation), technical developments or a shift in consumer preferences may affect businesses’ market value or creditworthiness (transition risk), or may affect confidence in businesses when their activities have a negative impact on the climate. This means the risks associated with the transition to a carbon-neutral economy could lead to a write-down of loans to and investments in companies.

The impact of climate-related risks on the liabilities side of the balance sheet strongly depends on the types of products that an insurer offers, Non-life insurers in particular may have to deal with the consequences of climate-related risks in the form of e.g. a rise in the number of claims, as a result of climate change and weather pattern shifts such as extreme rainfall and flooding (physical risk).

Life insurers, prepaid funeral services insurers and health insurers may have to deal with shifts in claims patterns as a result of climate change. For example, an increase in (lesser-known) tropical diseases in Europe and an increase in the likelihood of heat waves or other natural disasters resulting in casualties. This has an impact on insurers’ liabilities.

We have set out these risks in detail in our report "Waterproof? An exploration of climate-related risks for the Dutch financial sector".

If the risks are material, we expect the institution to set out a relevant scenario for them in the ORSA. This applies to both physical risks and transition risks.

Our good practices document "Principles for addressing climate-related risks in the ORSA provides further guidance" (Should there be any discrepancies between the Dutch and the English version of this good practice document, the Dutch version shall prevail.)

In 2018, the European Commission requested the European Insurance and Occupational Pensions Authority (EIOPA) to investigate how sustainability could be integrated into the Solvency II framework. EIOPA recently published its opinion on this topic, and emphasised among other aspects the importance of climate scenario analyses, indicating that this could be addressed in the ORSA1. The European Commission will consider this opinion. The actual impact on current legislation and regulations is yet unclear.

[1] EIOPA Opinion on Sustainability within Solvency II