Climate risk assessment of the sovereign bond portfolio of European Insurers

Abstract

In the first collaboration between climate economists, climate financial risk modellers and financial regulators, we apply the CLIMAFIN framework described in Battiston at al. (2019) to provide a forward-looking climate transition risk assessment of the sovereign bonds’ portfolios of solo insurance companies in Europe. We consider a scenario of a disorderly introduction of climate policies that cannot be fully anticipated and priced in by investors. First, we analyse the shock on the market share and profitability of carbon-intensive and low-carbon activities under climate transition risk scenarios. Second, we define the climate risk management strategy under uncertainty for a risk averse investor that aims to minimise her largest losses. Third, we price the climate policies scenarios in the probability of default of the individual sovereign bonds and in the bonds’ climate spread. Finally, we estimate the largest gains/losses on the insurance companies’ portfolios conditioned to the climate scenarios. We find that the potential impact of a disorderly transition to low-carbon economy on insurers portfolios of sovereign bonds is moderate in terms of its magnitude. However, it is non-negligible in several scenarios. Thus, it should be regularly monitored and assessed given the importance of sovereign bonds in insurers’ investment portfolios