Environmental, social and governance (ESG) issues are rarely out of the headlines these days, be it climate change-related disasters, boardroom corruption or new reporting requirements giving executives headaches.
In 2018, environmental law firm ClientEarth requested that the Financial Conduct Authority (FCA) investigate three household UK insurance companies for alleged failures to communicate their exposures to climate change-related risks to shareholders in their annual reports.
But while ESG may have been front of mind for some time with respect to carriers’ underwriting philosophies, when it comes to their investment portfolios the situation is more mixed.
Previously labelled as “responsible investing”, ESG has evolved and grown in prominence over the past two decades with regards to asset managers investing on behalf of institutional investors.
For specialty (re)insurers, the attraction and subsequent take-up has been smaller than for life and retail carriers, but is all that about to change?
What’s in a name?
ESG today can broadly be described as a set of metrics used by investors to assess a company’s risks – which may not be captured by conventional methods – with the intention of enhancing long-term returns.
The environmental part could encompass how a company performs as a steward of the environment, including how it looks at climate change, carbon emissions and pollution.
Social criteria include how companies manage relationships with staff and stakeholders, while governance considers a company’s leadership, executive pay, audits and internal controls. It can also look at board composition, transparency and business ethics.
Historically, asset managers looking to offer an ESG approach to investing only considered equity holdings – typically applying “sin stock” filters to passive portfolios to exclude companies from their index plays that are considered “bad”.
But over the five years to 2018, ESG strategies have become more sophisticated, applying a more holistic approach that includes applications for fixed income holdings.
This change in approach appears to have driven greater interest in the strategies from (re)insurers, albeit from a slow starting point.
“Insurers are starting to wake up and starting to consider to a larger degree how much they should adopt ESG and climate change considerations within their portfolios,” says Sean Thompson, managing director at Camradata.
“Regulation will play a large part in driving these changes through. That said, insurers should wake up a bit earlier and they’d be wrong not to start thinking about it themselves before that.”
Mazars partner Michael Tripps agrees: “The regulatory push is definitely there, the Financial Stability Board at a global level has given guidance so there’s global regulatory influence, as well as the PRA [Prudential Regulation Authority] and FCA here.
“There is also increasing awareness as the generations come through, and that will only grow. And the depth of analysis has developed, along with the way asset managers are selling the products,” he adds.
Other key drivers include reporting requirements, pressure from shareholders and increased awareness from both the executive committees at carriers and their staff.
Desire to improve
Patrick Liedtke, head of the financial institutions group at BlackRock, notes it is not just external pressures pushing insurers to engage with ESG. A heightened interest from insurers’ own staff is at play too.
“There’s the insurer’s own desire to improve, which is creating opportunities – whether that’s creating new products, investing in renewable energy, finding new markets which diversify portfolios and providing access to other income streams over a sustained period of time,” he says.
“We’re also seeing that the original move to create a few products – mostly equity-driven, which included ESG components – has been replaced by a comprehensive view of the world in terms of what ESG means. It’s about integrating ESG thinking into the whole investing universe.”
He adds that, while screening of certain companies remained an important tool, other areas such as impact investing and benchmarking investments for ESG were also being demanded in parallel, placing higher demands on asset management companies.
“If you look at the Nordics and the Netherlands there isn’t a single RFP [request for proposal] now that doesn’t include a chapter on ESG. As an asset manager, if you can’t do at least some of it, you’re not even allowed to play anymore,” he explains.
Axa Investment Managers’ (Axa IM’s) global head of responsible investment, Matt Christensen, says the management of ESG data in particular has improved, and is now used to develop a better understanding of tail risk and generate ESG scores for a wider array of investment opportunities.
“It’s not about a good or bad company, it’s more nuanced now. It takes that nuance of understanding to make decisions,” he explains.
Growing interest
A recent investment survey of global (re)insurers carried out by BlackRock demonstrates the rising interest in ESG. More than 90% of carriers in Asia Pacific and Europe said having an ESG investment policy was either extremely or very important, along with 67% of US carriers.
Laurent Clamagirand, chief investment officer of Axa Group, told the report’s authors that Europe was ahead of the game – not only because of legislation but also due to the mindset of the investment community.
Questions over whether insurers in the US were legally entitled to focus on anything other than maximising investment returns have also held back ESG developments there, he argued.
The majority of both North American (59%) and European (58%) insurers have already adopted an ESG investment policy, along with 49% of their Asian counterparts.
And most of those which do not already have an ESG investment policy expect to adopt one over the next 12 months.
Other key findings from the survey showed insurers were more likely to prioritise labour policies and relations, shareholder rights and diversity, as well as business ethics and transparency over other ESG issues. However, 68% of US carriers viewed climate change as extremely or very important.
The implementation game
Despite the sophistication of offerings, it appears that there remains a great deal of uncertainty about how best to implement ESG into insurers’ investment policies.
Even Zurich, which has a well-developed ESG programme, says it starts to apply ESG principles only when it reaches the point of selecting asset managers, as opposed to making it a factor in the company’s fundamental decisions on strategic asset allocation.
Swiss Re argues that, by moving to ESG-focused benchmarks for all its major asset classes, it is able to capture ESG factors in its asset allocation process.
Asked which approach to ESG they favoured in their investment activities, almost half of the respondents to the BlackRock survey cited impact investing (48%), followed by use of a thematic focus on particular ESG issues (43%). Thematic investing and exclusion were next on the list.
A lack of internal expertise exacerbates the situation, with most insurers lacking anyone in-house who can take ownership of the issue and ensure that asset managers responding to RFPs aren’t simply “greenwashing” the investors with their wares.
Worth the investment?
While the jury remains out on ESG in terms of whether the strategy produces outperformance compared to non-ESG investing, there is a growing consensus that it at least won’t negatively affect your returns.
“I’ve seen presentations that show how applying ESG to the investment process has managed to achieve similar returns to portfolios without ESG,” says Camradata’s Thompson. “I’m not saying that’s always the case, [but] managers are showing that you can factor ESG into your investments without having a negative effect on your investment return – and you’re seen to be more socially responsible as a result.”
BlackRock’s investor survey found that 55% of respondents felt they had to sacrifice an element of diversification to implement an ESG strategy, given that certain types of asset would be excluded from their investible universe.
And more than a third felt they should expect to give up some excess return, but only 9% were concerned about reduced investment income.
For insurers considering venturing into ESG for the first time, there are a few key recommendations to ensure you avoid being “greenwashed” by enthusiastic asset management marketers.
Firstly, do check that your asset manager has signed up to the UN-supported Principles for Responsible Investment (PRI) initiative, but don’t just stop there.
“Merely appointing an asset manager because they’ve got the UN PRI box ticked won’t wash,” says Camradata’s Thompson.
“Insurers will need to better assess how those managers integrate ESG into their processes. Is the decision purely made on returns? Or do they consider the end company’s actions from an ESG perspective? And is there a serious amount of research being done at these firms by the asset managers, not just looking at the credit rating but everything else?”
Axa IM’s Christensen also notes that it is important for asset managers to prove that ESG thinking flows from the very top of the firm, as well as being properly resourced with investment teams lower down.
“If you have a team that says we’ve hired five people last week, that’s not the same as a firm that has history in the field for the past 20 years, unless those newcomers bring a lot of experience to that team,” he adds.
“On the other hand, I’ve also seen that the longevity factor, those people who’ve come from one background and haven’t been able to adapt to an extremely changing environment, can also be a risk.”
This article was first published in the Winter 2018 issue of Insider Quarterly.
