The Role of Prudential Regulation and Supervision of Insurers in Sustainable Finance

This chapter addresses the role of prudential supervision in sustainable finance from the insurance sector perspective. The ability of the insurance and reinsurance sector to contribute to the objectives of the sustainable finance agenda, such as its role in the green transition, is closely intertwined with prudential considerations, such as the ability to (continue to) take insurance risk, its exposure to sustainability risk through its investments and its ability to include sustainable investments in its investment portfolio, while safeguarding a prudent level of policyholder protection. The European Commission and society more generally attribute a crucial role to the financial sector in the green transition. This includes certainly the insurance and reinsurance sector and fits within the broader efforts to connect finance with the specific needs of the European and global economy for the benefit of the planet and our society. This chapter focuses on the manner in which the prudential challenges, connected to sustainable finance, are addressed for the insurance and reinsurance sector, in particular through the Solvency II framework. A key role in respect of sustainability risks is attributed to the Own Risk and Solvency Assessment (ORSA), a crucial element within Solvency II. To the extent risks are not captured by solvency capital requirements, they might be captured, at least partly, by the ORSA that takes a longer-term perspective to the capital needs of insurance and reinsurance undertakings than the capital requirements do, which is a relevant notion in relation to sustainability risk. Furthermore, as institutional investors, insurance and reinsurance undertakings may represent an important source of funding for the sustainable transition. While, certainly under Solvency, insurance and reinsurance undertakings enjoy freedom of investment, they are, at the same time, bound by the prudent person principle, which compels them to invest in the primary interest of policyholders and beneficiaries. In addition, investment and underwriting risk should be reflected in the capital requirements. Therefore, it is crucial that insurance and reinsurance undertakings are conscious of the risks they accept, be it through their underwriting activities or through their investments. In recent years, significant efforts have been made to make progress in this respect, initially within the existing Solvency II framework, which has been designed in essence as agnostic to the types of risks and should therefore be capable of addressing sustainability risks as well, and gradually as well through amendments to the Solvency II Delegated Regulation, focusing on pillar 2 requirements and gradually exploring ways to incorporate sustainability in pillar 1 as well, including in capital requirements. In particular in this last area, further efforts are still required to appropriately capture sustainability risks, while maintaining a sound prudential framework for insurance and playing a significant role in the sustainability transition.