‘Solvency II’ overhaul of insurance industry regulation is ignoring huge climate risks

This article, by Lab CEO Jesse Griffiths, was originally published in Financial News London. It can be found here.

The Prime Minister’s portrayal of ongoing ‘Solvency II’ insurance industry regulatory reforms as being about getting rid of an “EU diktat which has been unnecessarily preventing … giant investments in UK firms and in infrastructure” is highly misleading.

Solvency II refers to the major changes to the regulation of insurance companies that were introduced to reduce risks to consumers and the wider economy in the wake of the global financial crisis.  One by-product of the government’s proposed changes to Solvency II will be that insurance companies will gain around £22 billion of capital that had previously been set aside to protect policyholders and the overall system should they fail. The Prime Minister misleadingly suggests that this will be directed towards UK firms and infrastructure, but there is nothing in the proposals to ensure this: companies could equally well use the money to boost staff pay, pay dividends to shareholders, or anything else they care to prioritise.

This is not, however, the most misleading part of the Prime Minister’s statement. By suggesting that financial regulation to protect us all from major risks is ‘unnecessary,’ he brushes aside concerns that proposed reforms will make the system more risky, and crucially that they ignore the biggest risk of all: climate change.

Both the impacts of climate change, and the need to change insurance to reduce climate risks are having massive impacts on the insurance industry. Swiss Re has estimated that climate change could lead to 200% increase in insured losses due to flood damage in the UK, and add $183 billion to annual house insurance premiums globally in the coming decades, for example. Yet, while many UK insurers have made important commitments on net zero, they are far from playing their part in helping us all prevent catastrophic climate change: insurance companies continue to be both major funders and underwriters of fossil fuel investments for example.

Solvency II is the first major reform of the financial system since the government promised to make the UK the world’s first net-zero financial centre, but climate risk is completely ignored in the reform proposals.  For example, the second major part of the reforms, to the ‘matching adjustment’ which affects how insurers can account for over £300 billion of long-term assets and liabilities on their balance sheets, is an obvious area where climate should play centre stage. The adjustment incentivises insurers to invest in certain assets and not in others, and so could be used to reduce investment in fossil fuels and boost funding for green alternatives.

These are changes that could be made within the narrow remit of the existing reforms, but if the government really prioritised making the UK financial centre net zero, much more could have been done. Indeed, changes to insurance are just the first in a wave of regulatory reforms sweeping the UK financial system: over 130 at last count. At the centre are proposals to shift the rules of the game by giving powerful financial sector regulators major new powers, while changing their statutory objectives. The Solvency II proposals are a warning sign: unless regulators are given a strong legal mandate to prioritise climate transition, they will too often fail to prioritise it against the competing demands coming from the industries they are regulating. As the impacts of climate change become ever more severe, and the risks of catastrophic economic and financial outcomes grow we cannot continue to regulate insurance, and the wider the financial sector, as if these risks did not exist.