A comprehensive package of measures to improve the transition towards more sustainable finance activities in the European Union (EU) was adopted by the European Commission (EC) on 21 April 2021. It included six delegated acts which will amend various sectoral regimes, including the Insurance Distribution Directive (IDD) and Solvency II regimes.

Other measures in the package are the EU Taxonomy Climate delegated act and a proposal for a Corporate Sustainability Reporting Directive. In short, these provide for technical screening criteria for environmentally sustainable economic activities and various disclosure, reporting and similar obligations.

The two delegated acts amending the IDD and Solvency II regimes focus on the integration of ‘sustainability’ or environmental, social and governance (ESG) considerations and factors into key activities including investment advice, product oversight and governance, risk management and suitability assessment procedures.

Key changes to the IDD Regime

The IDD amending regulation (the IDD Regulation) integrates sustainability factors, risks and preferences into product oversight and governance requirements for insurance undertakings and insurance distributors and into the conduct of business rules and investment advice for insurance-based investment products (IBIPs).

The key ESG-related modifications of the IDD include:

  • Product oversight and governance requirements: Manufacturers of insurance products will need to factor sustainability-related objectives of customers into the product approval and product testing processes for each insurance product as well as their target market identification processes and distribution channels. Additionally, sustainability-related objectives will need to be factored into distribution arrangements.
  • Conflicts of interest: Distributors of IBIPs will be required to integrate sustainability factors into their processes for identifying conflicts of interest which may damage the interests of a customer or potential customer. For example, where a customer's 'sustainability preferences' conflict with the investment returns generated under the IBIP.
  • Product suitability assessment: Distributors recommending IBIPs are required to obtain information about a customer to determine the customer's suitability for a particular product and this includes assessing the customer's preference for risk taking and risk tolerance. Generally, suitability assessments may not include questions on a customer's 'sustainability preferences' so sustainability factors are not taken into account. The IDD Regulation is focused on ensuring sustainability factors are integrated into product suitability assessments and the pre-contract suitability statement for IBIPs.

Key changes to the Solvency II Regime

The Solvency II amending regulation (the Solvency II Regulation) introduces obligations for (re)insurance undertakings to manage 'sustainability risks' and ensure sustainability factors are taken into account in risk assessment.

The Solvency II Regulation integrates sustainability factors into a (re)insurers’ risk management system and identifies four key areas in which sustainability risk must be incorporated:

  • Risk management and the tasks of the risk management function
  • Actuarial function and the assessment of the uncertainty with calculating technical provisions
  • Remuneration policy and how it accounts for sustainability risks in the risk management system
  • Integration of sustainability risk in the prudent person principle

When will these changes apply?

The expectation currently is that the IDD Regulation and Solvency II Regulation changes will apply from October 2022. Both regulations have yet to complete the EU legislative process. They will come into force 20 days after publication in the Official Journal of the EU and will apply 12 months after the publication date.

While October 2022 may seem some time away, integrating sustainability factors will require a holistic approach. Our sense is that it would be easy to underestimate the amount of work and input from a variety of business functions that will be required. In-scope firms may therefore wish to focus sooner rather than later on how they will comply with their obligations.