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April 19, 2024

Why the insurance industry needs to step up and finance the green transition

People watch as waves crash against the sea wall at Porthcawl, south Wales, on February 18, 2022 as Storm Eunice brings high winds across the country.
Insurers play a crucial role in helping to ensure the resilience of local economies in the face of natural disasters © AFP via Getty Images

Ursula Woodburn is director of the University of Cambridge’s Institute for Sustainability Leadership Europe office and the Corporate Leaders Group Europe

MEPs can vote next week to make certain that EU insurers use their capital to support businesses in their net zero transition

Insurers are at the sharp end of many climate debates. They play a crucial role in helping to ensure the resilience of local economies in the face of natural disasters as risks to people and infrastructure increase – whether that is down to heavy flooding, as northern France experienced in January, forest fires, which are becoming more frequent in the Mediterranean, or failed harvests decimating crops in Portugal, Spain and Italy year on year. 

However, insurers should also be using their capital to help stop these extreme weather events happening in the first place by supporting businesses on the road to a sustainable economy.

In the EU, steps are being taken to make this reality. For nearly three years, the European Council and parliament have been negotiating a proposal to amend Solvency II, the EU directive that sets out the regulatory requirements for insurance companies on governance, accountability and risk.

The main thrust of the legislation is to ensure the solvency of the industry and its ability to stay afloat and remain a stabilising force amid market, and climate, volatility. 

Widely regarded as the world’s gold standard for insurance legislation, Solvency II came into force in 2016 and, in 2021, the European Commission decided to review the directive.

Discussions on how to amend the text to make it better fit today’s challenges have been heated. However, in December 2023, a provisional agreement, aimed at boosting the role of the insurance industry in managing climate change and helping it to be better prepared for future shocks, was reached

It is crucial that MEPs vote in favour of these amendments in a final vote in the European parliament on April 22 and free up capital to invest in the green infrastructure and technologies needed to decarbonise our economy.

The amendments should incentivise insurers to invest in long-term capital for the economy, particularly that focused on supporting the aims of the Green Deal. Parliament estimates the directive can release around 100bn.

Under the existing rules, European insurance companies are required to hold hundreds of billions of excess capital above minimum reserves.

The proposed amendments to Solvency II would give them greater headroom to invest more in the green transition and to better take into account potential damage to the environment and society from their investments. 

It will also include provisions obliging firms to consider sustainability-related risks. If EU member states are serious about achieving climate neutrality by 2050, insurance and reinsurance companies will need to develop plans, quantifiable targets and processes to monitor risks arising in the short, medium and long-term from climate change and related to biodiversity loss.  

Risk assessments will be important for insurers to ensure they can price their products accordingly and innovate and develop insurance products tailored to a world with more intense and frequent weather events.

Improved data collection, monitoring, forecasting, and early warning systems will all be needed.

Fostering a robust insurance and reinsurance sector in Europe will play a pivotal role in enhancing the region’s resilience and competitiveness.

Improving the mechanisms that govern the sector will not only provide financial stability in times of crisis, but also facilitate risk management strategies for businesses, promoting economic growth and stability across the EU.  

The vote on Solvency II is being squeezed in before the end of this parliamentary term.

It would be wise of MEPs to approve it to give the insurance industry some much-needed clarity and to help unlock the green investment the economy so badly needs.  

A service from the Financial Times