In 2022, Zurich received a rating of AAA (on a scale of AAA-CCC) in the MSCI ESG Ratings assessment. Its FTSE4Good Index Series ESG Rating in June 2022 was 4.0 (highest score - 5). Like credit and financial strength ratings, such ESG ratings are a little controversial. On the one hand, they’re seen as a crucial element of much needed corporate ESG scrutiny, for insurers and their corporate clients. On the other, there’s a number of ratings providers and they don’t always agree. What’s your take?
There’s a lot of ESG data that third party companies generate on all three topics. The trouble is that it is often derived, or modelled data built from assumptions. So frequently there isn’t much correlation between providers: the same company might be rated differently (as an investment) by different data providers.
It’s a bugbear at a time when for the last five years asset managers have created more ESG funds, which incorporate ESG ratings to a greater or lesser extent. In recent years the out-performance of these funds compared with non-ESG funds has often been driven by the incorporation of tech stocks (where ESG issues are often ambiguous at best).
How can the quality and availability of ESG data be improved?
The insurance industry has worked hard at modelling natural catastrophes like windstorm rather than relying wholly on individual third party vendor ‘black box’ approaches, built on proprietary data and models. A similar thinking could be followed with ESG risk data.
[For nat cat risk] Zurich along with some other insurers have supported the creation of an open-source risk modelling platform through the Insurance Development Forum (IDF). It’s evolved to the point where this [open source] capability is part of the World Bank’s Global Shield Financing Facility, the joint initiative launched at COP27 to better protect poor and vulnerable people from disasters by pre-arranging more financing before disasters strike.
The insurance industry, as asset owners and institutional investors, can play an important role in encouraging the disclosure of ESG data. ESG doesn’t have to be left to third party providers, insurers can encourage standardisation of disclosures by companies through for example the IFRS’s International Sustainability Standards Board (ISSB), which aims to homologate the existing plethora of sustainability disclosure standards from the World Economic Forum Global Reporting Initiative (GRI), the Financial Stability Board’s Taskforce on Climate-related Financial Disclosures (TCFD) and others.
Could the industry eventually produce an open source platform for ESG risk? It’s a bigger task than for nat cat modelling, and might include insights on a variety of sustainability topics, such as the efficacy of net-zero transition plans that could help investors discern if companies are “greenwashing”, but the industry, governments and regulators do recognise there is a need for such standardisation. The IFRS and the FSB initiatives are a good place to start.
Since the Ukraine war there has been a shift in investment strategies, away from tech for example, which is more favourable from an ESG point of view. In the short term, returns from oil and gas and defence stocks now look more attractive compared with tech and low carbon investments. Has it turned the tide of opinion on ESG?
Some people are saying ‘shouldn’t you just be focusing on fiduciary responsibilities’ – in other words making money, rather than ESG considerations? So there is a backlash against ESG, especially in the US. It’s a side effect of the highly politicised divisions in American society.
I think that is totally wrong. The reality is that it’s important to look at broader risk issues because they are risks to the investment case. As Ron O’Hanley, The CEO of State Street recently put it, it’s ‘a matter of value, not values.'
The recent WEF Global Risk Report showed how big socio-economic crises have totally transformed the world. But it doesn’t mean we can afford to ignore the longer term issues around climate change. Energy systems have to be transitioned to a lower cost, lower carbon and more secure source.
The role of supervisors and specifically central banks has become a talking point. Jerome H Powell, the governor of the US Federal Reserve, said that central banks should not get involved in issues like climate change that are beyond their statutory established mandates. What do you think?
He is right to say that managing monetary policy, prudential risks and protecting consumers is what central banks, financial regulators and supervisors should be doing. But some sustainability risks such as those posed by the net-zero transition are truly systemic and should be recognised as such in investment strategies.
The TCFD and the EU’s sustainable finance action plan taxonomy were positive steps but it turns out that [climate transition risks] are more complicated than that and there are “fifty shades of brown or green”. There are also other issues to take account of in sustainable investments, such as not significantly harming other environmental or social objectives (Do No Significant Harm) – for example the impact of radioactive waste in lower carbon energy from nuclear – which are enshrined in the EU SFDR (Sustainable Finance Disclosure Regulation). We have to invest in and support the transition and insurers have an important role as investors and underwriters, especially around the phasing out the demand for fossil fuels like coal.
Existing insurance regulation such as solvency rules are very important to create transparency, level playing fields and ensuring insurers are able to discharge their responsibilities to their policyholders. Recent proposals and discussion at supervisors, such as the IAIS (International Association of Insurance Supervisors) and European and UK supervisors such as EIOPA (European Insurance and Occupational Pensions Authority) and the UK PRA, have focused on understanding and communicating climate risks, especially through bilateral communications such as the ORSA (Own Risk and Solvency Assessment) process.
That makes sense, even if the very long-term time horizons of scenario-based climate risk assessments (multiple decades in the future) don’t match the short (one year) to long-term (three year) strategic plan horizons in most businesses.
So are regulators moving in the right direction policy-wise?
Where it has the potential to go awry is looking to apply capital to those very long-term and uncertain future risks.
Many of these risks won’t materialise for another 20-30 years and may, or may not happen, so it doesn’t make sense to apply capital to something that may or may not happen on such a long time scale. It risks distorting current insurance markets, potentially making insurance unaffordable for customers at a time when it is really needed to create resilience in society.
ESG and climate risks are important near-term and longer-term strategic considerations for insurers - but there are limits as to what insurers can influence. Policymakers need to think carefully and work with the industry to understand where policy innovation can help, or hinder progress in tackling and building resilience to climate change. For example policies that encourage investment in climate risk adaption and resilience, or policies which support closing the insurance protection gap of communities vulnerable to climate risk.
