EIOPA recommends higher capital requirements for insurers’ fossil fuel assets

Insurers in the EU may soon need to set aside more capital for their fossil fuel assets to cushion against climate change risk.

The European Insurance and Occupational Pensions Authority (EIOPA) recommended that fossil fuel stock and bonds held on European insurers’ balance sheets receive additional prudential treatment to accurately account for the higher risk of such assets.

The report was given following a mandate by the European Commission to assess the potential of dedicated prudential treatment for assets associated with environmental and social objectives or those that could harm those objectives.

EIOPA’s analysis found that fossil fuel stocks and bonds are more exposed to transition risks than other economic activities and present a financial risk. EIOPA has proposed raising the capital requirements by 17% for stocks and 40% for bonds.

“While expert judgment is necessary to address empirical uncertainties and ensure shock factors remain within reasonable bounds, this option represents a pragmatic approach for enhancing financial resilience of the insurance sector,” Petra Hieklema, chairperson of EIOPA, said in a letter to the commission.

Although the EIOPA board of supervisors voted to support additional capital requirements, not everyone agreed. Some expressed concerns about the methodology and data used, while others raised worries about the potential for double counting and concerns that the costs for implementing the measures could outweigh the benefits.

The report also analysed to what extent climate-related adaptation measures can lower risks for insurers and found that, while there is a potential risk reduction, more research is needed higher-quality data becomes available. EIOPA also looked at how social risks can translate into risks for insurers but did not recommend a specific prudential treatment due to a lack of data and risk models.

Jérôme Crugnola-Humbert, a former sustainable finance policy expert with EIOPA, said the decision was “groundbreaking”.

“While it was motivated by microprudential considerations about transition risks, in other words the risks that a shift away from fossil fuels may devalue these assets, it is also welcome from a macro-prudential and financial stability perspective, since it disincentivises financial support for a sector which fuels systemic physical risks,” he said.

Several organisations welcomed EIOPA’s decision and called on the European Commission to adopt its recommendations.

The policy recommendations are based on empirical evidence and “provide a basis and an obligation for regulators to act and deliver on their financial stability mandate”, said Julia Symon, head of research and advocacy at Finance Watch

“Addressing these risks is essential for the future of the insurance sector itself, as climate change is already undermining insurers’ business models today,” she said.

Paul Schreiber, senior policy advisor at Reclaim Finance, said that all financial regulators in the EU should follow EIOPA’s recommendation, not just insurers, as it is “critical for the resilience of the financial system”.

Meanwhile, Caroline Metz, EU policy manager at ShareAction, said the report sends a strong signal on the link between climate change and financial stability and “are especially important as they respond to industry and policy concerns that regulation should remain risk- and evidence-based”.

She said the EU should act on the findings “to remain a global leader in sustainable finance”.

“Time is running out, and bold action is critical to safeguard our economy and its people from the present and future risks of fossil fuels investments.”