The European Insurance and Occupational Pensions Authority (EIOPA) has released a discussion paper on proactively managing sustainability risks, focusing on the real estate sector.
The paper highlights the crucial role that real estate markets play in the transition to a low-carbon economy and society, as the construction and energy use of buildings contribute significantly to greenhouse gas emissions.
Building operation accounts for 40% of total energy consumption and 36% of energy-related greenhouse gas emissions in the European Union.
Improving the energy efficiency of buildings in the EU is estimated to reduce overall energy consumption by 5-6% and carbon dioxide emissions by around 5%.
However, 75% of the EU’s building stock is considered energy-inefficient according to current building standards, and on average, the annual renovation rates of the building stock correspond to less than 1%.
Insurers in the EU allocate around 8% of their investments to real estate, and potential changes in the value of these assets due to energy efficiency could significantly impact their balance sheets.
The Energy Efficiency Data Protocol and Portal (EeDaPP) has conducted research showing that investments in improving the energy efficiency of buildings can lead to an increase in the valuation of the asset due to lower energy consumption and can also reduce the risk of mortgage default.
Real estate valuation is usually based on transactions for which the corresponding data is not publicly available, so the error rate is relatively high.
Therefore, the EIOPA discussion paper focuses on the potential transition risk in terms of the energy performance of buildings and how this could affect the calculations made for prudential purposes under the Solvency Directive II.
In addition to the financial risks associated with energy-inefficient buildings, there are also social risks to consider.
On average, 20.1% of a household’s disposable income in the EU goes towards housing expenses, and energy costs have significantly increased in the past decade.
Inflation-adjusted electricity prices, for example, have risen from €0.16 per kWh in 2008 to €0.24 per kWh in 2021.
These rising energy costs can disproportionately impact lower-income households and contribute to energy poverty.
The EIOPA discussion paper notes that the impact of energy consumption on a household’s disposable income is a key factor in the vulnerability of households to energy poverty.
To address these risks and promote sustainability, the EIOPA discussion paper suggests actions for insurers, including incorporating sustainability risks into their risk management processes, engaging with policyholders and other stakeholders on sustainability issues, and supporting the transition to a low-carbon economy through investments and partnerships.
The paper also recommends that the EU consider establishing a framework for integrating sustainability risks into prudential regulation.
Green bonds are a potential avenue for promoting sustainability in the real estate sector.
Green bonds are financial instruments issued to fund projects with environmental benefits, such as renewable energy or energy-efficient buildings.
The market for green bonds has grown significantly in recent years, and insurers have the opportunity to play a role in this market by investing in green bonds and supporting sustainable projects.
Another important aspect of promoting sustainability in the real estate sector is the use of building energy performance certificates (BEPCs).
BEPCs are documents that provide information on the energy performance of buildings and are used to assess the energy efficiency of buildings and identify opportunities for improvement.
The EIOPA discussion paper suggests that insurers could use BEPCs as a tool to assess the sustainability risks of their real estate investments and engage with policyholders on energy efficiency measures.
The above creates significant needs for data collection and analysis.
Although this process has costs, it also represents a unique opportunity for insurance companies to upgrade their infrastructure automating processes to reduce costs and increase their income through better pricing of lower risk customers and immediacy of sales through the Internet.
Fortunately, for insurance industry professionals, data are available to help them make the right decisions.
What remains is for them to work with the right organisations to help them gather and analyse this data properly.
By Pavlos Loizou, CEO, Ask WiRE