UK seeks to boost green investment with insurance rules overhaul

UK authorities are pressing ahead with plans to reduce the amount of capital insurers are required to hold in a bid to unlock billions of pounds of investment, including for the low-carbon transition. However the reforms do not include measures to improve the sector’s resilience to climate risks, as climate advocates have been calling for.

The Treasury and Bank of England (BoE) have each launched consultations on potential reforms to Solvency 2 – the regulatory regime for the insurance sector which the UK inherited while a member of the European Union.

Economic secretary John Glen said in February that, following the UK’s exit from the bloc, insurers should be given significantly more flexibility to invest in long-term assets such as low-carbon infrastructure, without compromising on protections for policyholders. Prime Minister Boris Johnson said that this, alongside other measures, would produce an “investment big bang”, and contribute to the creation of hundreds of thousands of green jobs.

Among the most significant measures being consulted on is a 60-70% reduction in the risk margin for life insurers. The risk margin requires an insurer to hold extra capital in case its liabilities have to be transferred to another provider. The Treasury’s consultation document says that cutting this requirement will allow firms to redeploy large volumes of capital elsewhere.

The government is also considering changes to the matching adjustment regime. This allows insurers to match certain types of investments against their liabilities. Under current rules, these investments are required to generate a cash flow that is fixed in its timing and amount, which precludes the use of investments in areas such as green energy infrastructure. The government aims to address this by expanding the range of assets that are eligible.

Although the government has talked up the potential of unlocking greater investment in the low-carbon transition, civil society groups have called for action to address the risks associated with the insurance sector’s exposure to fossil fuels. The responsible investment charity ShareAction has found that top insurance companies are systematically failing to assess the impact of climate change and the green transition on their investment portfolios.

In an earlier call for evidence, the government acknowledged that insurance firms holding assets for a long period may be exposed to increased levels of transition risk arising from climate change. It said this was a particular issue for firms that use the matching adjustment, and sought input on how the mechanism could be amended in light of these risks.

Carbon-intensive assets are thought to be over-represented under the current eligibility framework, which industry experts have warned is resulting in significantly more insurance capital flowing towards polluting firms, enabling them to expand at a greater rate than they would otherwise have done.

A submission by the environmental law charity ClientEarth argued that fossil fuel and other high-carbon investments should be ineligible for the matching adjustment. It cited the risks associated with them, and their incompatibility with the government’s own commitment to align private sector financial flows with the net zero transition.

ClientEarth is also calling for the solvency capital requirements (SCR) calculation to be enhanced to better reflect climate risks. It is concerned about the risks insurers may face both through their investments, and through their liabilities, particularly due to the likelihood of more frequent and costly natural-disaster related claims.

The group wants the government to consider requiring firms  to hold additional capital against investments and liabilities linked to fossil fuels, in particular to new fossil fuel projects. The Treasury has already acknowledged that, while the SCR is the “logical place” for firms to allow for climate risks, the current SCR calculation is not well suited to reflecting them.

ClientEarth and other groups including Finance Watch and ShareAction are making similar demands of the European Union (EU), which is currently reviewing its own Solvency 2 regime. Like the UK, the EU says its proposed reforms will facilitate greater investment in the green transition, but climate advocates say it is not doing enough to address the mounting sustainability risks facing the sector.