EU must unlock insurance sector’s potential to catalyse green investment
World leaders have come together in Davos for the World Economic Forum’s first in-person winter Annual Meeting since the COVID-19 pandemic began. Running from 16 to 20 January, Davos 2023 has seen heads of state, business executives and international organisations seek collective solutions to inflation, a looming recession and a green transition imperiled by these economic headwinds.
Talks at Davos have notably highlighted the need for future-oriented investment to generate sustainable growth. Earlier this month, the WEF identified climate change as the global economy’s primary long-term menace, yet fears abound that a transitory fossil fuel backslide will put climate targets increasingly out of reach.
Given the bleak economic and budgetary situation facing European governments, Brussels must ensure its forthcoming policies help unlock the full potential of private sector investment in developing the bloc’s green industries.
A daunting year ahead
While the EU has defied fears of a significant gas shortage-induced economic downturn in 2022, the outlook looks less rosy for 2023. According to analysis from Goldman Sachs, Europe is heading towards a recession this winter, pointing to data indicating “a sizeable slowing in energy-intensive industries,” while warning that “high inflation will reduce real household income.” What’s more, amid ongoing energy supply precarity and tightening fiscal policy, the OECD has projected weak eurozone growth of 0.5% this year, compared to 3.3% in 2022.
Adding further pressures are the legacy effects of COVID-19 on government coffers. High public spending on health and economic support to households and businesses paired with economic stagnation caused soaring public debt within the eurozone, with the debt-to-GDP ratios of countries including Greece, Italy and Portugal significantly exceeding 100%. To make matters worse, sky-high inflation is significantly boosting the costs of EU-funded national pandemic recovery plans and cost-of-living relief measures.
Diverging government interests
Given these budgetary constraints, the controversy surrounding emerging proposals for further relaxation of EU state aid rules to drive investment in domestic industry is understandable. While major economies like France and Germany have the headroom to massively subsidise key sectors, such as renewable energy, batteries and semiconductors, the bloc’s smaller, more cash-strapped countries risk being left behind by a drastic opening of the fiscal floodgates.
Germany and France, which account for nearly 80% of approved state aid under the Temporary Crisis Framework adopted last March, are naturally leading the calls for this additional state aid reform, yet the former is rejecting calls for a collective EU fund intended as a green investment counterbalance for weaker economies, citing an unwillingness to take on additional collective debt beyond the largely untapped EU pandemic recovery funds. In this fiscally and politically turbulent climate for public investment, the private sector must step up.
Setting stage for insurance investment
Given its long-term business model and status as Europe’s largest institutional investor, the insurance sector is ideally suited to complement public industrial investment. Insurers manage over €10 trillion in assets invested in the bloc’s economy and provide stable funding for both governments and businesses, while emerging as a leading green investor in recent years. Yet to fully capitalise on this investment potential, insurers need the right regulatory environment.
Insurance firms’ investment abilities are regulated by EU prudential legislation, namely the Solvency II Directive, which notably sets capital levels insurers must maintain to protect policyholders. With Solvency II currently under review in the European Parliament, led by German MEP and rapporteur Markus Ferber, an opportunity has emerged for MEPs to remove unnecessary regulatory barriers holding insurers back.
The fundamental issue lies in Solvency II’s failure to adequately account for the lower risk nature of insurers’ long-term investments, with heavy-handed capital buffers disincentivizing the sector’s financing of a sustainable post-Covid recovery. Moreover, these rules have been proven unjustifiable by the industry’s impressive financial resilience in recent years: 90% of insurance firms have maintained a solvency ratio – capital assets against policyholder obligations – above 150% while half have exceeded 200%, against a regulatory threshold of 100%.
The insurance sector’s excessively harsh treatment under EU prudential legislation is notably displayed by the “Danish Compromise” provision of the Capital Requirements Regulations (CRR), which applies less stringent capital requirements to banks with insurance company participations. At the same time, Solvency II does not provide the same advantage to insurance firms with stakes in banks, creating a market imbalance with knock-on effects for investment and economic growth. With the Solvency II review approaching its conclusion, there is a chance to negotiate amendments to level the playing field for insurers while protecting policyholders and tackling climate change.
Fueling homegrown green industries
Empowered by fair regulations in Brussels, the insurance sector would be liberated to unleash a wave of investment in the bloc’s green industries, helping to meet European Green Deal targets while boosting global competitiveness and creating jobs. The “European Sovereignty Fund” announced by the EU Commission last year presents an ideal vehicle for channeling insurance capital into strategic sectors, such as green energy, advanced technologies and raw materials mining, that will fuel the bloc’s “twin” digital and green transitions.
While details on its structure and finance sources remain vague, the Fund is essentially intended as an industrial investment counterbalance to state aid reforms that could leave smaller member-states at a competitive disadvantage. But as EU Council President Charles Michel has recently recognised, the Fund will clearly require significant levels of private capital to “close investment gaps that undermine long-term growth” and “generate wealth” through a collective effort.
Brussels’s long-term view for sustainable investment aligns with the World Economic Forum’s prescription for converging economic, energy and climate crises being discussed at Davos. Børge Brende, the Forum’s president, has recently highlighted the private sector’s role in building “a new resilience muscle,” which the insurance sector will be a key part of. With the stakes at a historic high, world leaders must make the right choices to protect citizens, industry and the planet.