1    Introduction

The heightened vulnerability of insurers to climate change necessitates urgent and strategic actions to integrate climate risks into their governance and strategies

Specifically, reform of the EU Solvency II Directive has created a new requirement^[1] for insurers to identify and assess any significant exposure to climate change risks and use climate scenarios within their Own Risk and Solvency Assessment (ORSA), which will be closely monitored by the European Insurance and Occupational Pensions Authority (EIOPA)[^[2]

Against this backdrop, this paper presents a possible approach for assessing the implications of higher carbon prices on the value of equities globally, through the following structure:

1. Vulnerability of insurers to climate change: we remind why insurers are particularly vulnerable to climate change. This section examines the specific risks posed by climate events to insurers’ financial health, and the implications for underwriting and investment portfolios.
2. Official climate scenarios may underestimate materiality of climate risks: we summarise the results of official climate scenarios that find limited risks for insurers. However, the UK actuarial professional industry body concludes that current climate scenarios underestimate climate risks
3. Deriving a carbon price from a new short-term climate scenario narrative: we use a new, short term climate scenario narrative developed by the United Nations Environment Finance Initiative (UNEP FI) and the National Institute of Economic and Social Research (NIESR) leading to higher carbon prices globally. This scenario incorporates more extreme assumptions to better reflect the potential adverse impacts on financial stability and to provoke the necessary strategic changes and awareness among investors.
4. Measuring the potential impact of higher carbon prices on the value of global equities: we analyse how the imposition of a more stringent carbon price could affect the value of global equities. This section also provides a comparative analysis between traditional and ESG equity indices for various regions, highlighting the financial implications of transitioning to a low-carbon economy.

Based on our proprietary analysis, we show that the impact of a higher carbon price on company equity value is significant, ranging from -10% to -15% for the MSCI World index, with a carbon price of USD 150/tCO₂ and USD 300/tCO₂. While this impact is consistently negative, it is less pronounced on ESG indices, which could encourage investors, particularly in Europe, to consider shifting their exposure from traditional indices to ESG indices in a capital preservation strategy.

By providing an in-depth analysis, this paper aims at guiding European insurers as they transition towards a more sustainable economy while ensuring their financial robustness in the face of future climate challenges. This analysis can also be seen as a useful guide for helping European insurers assess the impact of a given short-term climate scenario, in their ORSA, on the value of their portfolio invested in global equities.