Magazine Issues » July-August 2019

ESG: Of premium importance

Asia_ice_creamCompared to other institutional investors, how diligently are insurance companies incorporating ESG factors into their portfolios? It’s complicated, writes Fiona Rintoul.

Does environmental, social and governance (ESG) come naturally to insurance companies? Ed Collinge at Robeco thinks so.

“As a general premise, insurance companies are socially responsible investors,” says the firm’s global head of insurance strategy. “They are providing downside protection to people in unfortunate circumstances, so investing in social good is something that resonates well with insurance companies.”

But does that translate into insurers being ahead of other kinds of institutional investors in terms of integrating ESG factors into portfolios? Opinion varies, and the reason for that is rooted in the sector’s raison d’être: underwriting risks.

In client discussions, Gabriel Wilson-Otto, Asia-Pacific head of stewardship at BNP Paribas Asset Management, finds insurers are advanced in evaluating and modelling climate risk and similar types of ESG risk – but less so in other areas, such as governance and social rights.

“That’s because they’ve been seeing the impact of increased extreme weather events on claim frequency and intensity, and it actually has a very significant cashflow impact,” he says. “When it comes to broader ESG analysis across their entire portfolio and issues that may not be directly insured by them, you can start to see divergence of outcomes.”

Like other institutional investors, insurance companies are grappling with the detail of how to implement ESG effectively in the face of pressure from both regulators and consumers – as well as their own need to manage ESG risks. For now, the landscape within insurance is heterogeneous, making comparisons with other sectors difficult.

“Data on adoption levels can vary greatly by region, by insurer type, but also because of variable definitions of ESG,” says Marie Niemczyk, head of insurance relations at Candriam.

In terms of regions, Europe is broadly ahead, followed by Asia, with the US playing catch-up. However, there is considerable variation within regions. In Europe, France – which imposes climate-change and more general ESG reporting requirements on institutional investors – stands out, while in Asia, Japan is now leading the charge.

“If you speak to insurance companies in Japan, it’s completely at the top of their agenda,” says Collinge. “They’re building their ESG policies. Their product offerings and investment strategies going forward are based around ESG building blocks.”

As a result, sustainable assets under management in Japan have gone from $7 billion in 2014 to more than $2 trillion. And, according to Wilson-Otto, this “crazy ramp-up” in Japan and elsewhere comes from a different angle and different sources than in Europe and the US.

“It’s been very much regulation and policy-driven and international investors influencing the environment as well,” he says. “Within Japan, corporate governance reform and ESG was seen as one of the key enablers under [prime minister Shinzo] Abe’s three arrows of economic growth.”

Natural catastrophes
When it comes to types of insurers, it is, naturally enough, those most exposed to ESG risks that have thus far been most proactive in integrating ESG into their investment strategies. The past few years have seen record highs in terms of insured losses from natural catastrophes, notes Niemczyk, and so insurers that carry liabilities related to those risks, for example reinsurers, are having discussions about how to insure risks linked to climate change going forward.

“The next step is to ask how they can become part of mitigating climate change and some of its effects,” she says.

Certainly, climate risk – and divestment from fossil fuels – seems to be at the centre of many insurance companies’ current ESG strategies. According to Lise Moret, head of climate strategy – responsible investment, at Axa Investment Managers, almost 1,000 institutional investors with more than $6 trillion in assets have made public commitments to reduce investments in fossil fuel companies – particularly coal. And banks and insurers are using their muscles in other ways too. “Many banks and insurers have also limited the funding and underwriting business they do with these companies,” she says.

Mixing underwriting and ESG doesn’t always work, however. There can, for example, be privacy issues. “If an insurer has scored a company in the insurance part of the business, can they then transfer that data to the investment arm to make a judgement on whether they want to invest in that company?” asks Wilson-Otto. This is just one aspect of a data minefield afflicting the industry. Data availability is another issue.

“Even if you have a fantastic model that can accurately predict climate change, if you don’t know exactly where a company’s assets and customers are located, then your ability to predict impact from physical risk can be significantly limited,” says Wilson-Otto.

This helps explain why the sometimes blunt instrument of divestment is still important. Around half of the insurers surveyed for this year’s report on the European insurance industry from Cerulli Associates exclude industries that do not meet their ESG standards – including tobacco and coal – and apply ESG scoring to the remaining investable universe.

“The exclusion list is perhaps the easiest way to start,” says Justina Deveikyte, associate director, European institutional research at Cerulli Associates. “Fewer insurers integrate ESG considerations across the entire portfolio because it is more difficult and there is no one harmonised approach.”

Exclusions perhaps have their place. Certainly, Moret believes that Axa IM’s coal company exclusions are justified.

“We found our exclusion list across both equities and bonds removed between 2%-3% of our investible universe,” she says. “Clearly, on a global scale the impact of such a move is small. When coupled with the increasingly powerful sustainability arguments underpinning coal divestment, it suggests that any remaining reasons to be invested in coal companies are diminishing.”

Lagging behind
But if a lack of ESG integration across portfolios is a sign that insurers are lagging behind other institutional investors – and some feel they are – there are perhaps good reasons for that.

“Insurers have been faced with significant regulatory changes, for example Solvency II, which has had a big impact operationally and strategically on the investment side,” says Niemczyk.

However, this is changing fast. In Asia, for example, the negative screening and exclusions model of ESG implementation is being left behind. “The tone around ESG in Asia is much more about how you can marshal capital towards addressing the needs and shortfalls of funding that have been identified by governance,” says Wilson-Otto. For insurers, however, one hurdle can be the extent to which they typically invest in fixed income – or that, at least, is the perception.

“It is easier to apply ESG to equities, but insurers don’t invest much in equities,” says Deveikyte. “In some countries, insurers’ maximum allocation to equities ranges between 15%-20%, but more often than not it is below 10%.”
In the face of low bond yields, an evolution is certainly underway in how insurers invest, with greater allocations to corporate bonds and non-fixed income investments. However, fixed income still forms the backbone of most insurers’ investment strategies.

Integrating ESG into such a strategy is an area where asset managers can perhaps help their insurance clients most. Robeco, for example, has built a framework around the UN 17 sustainable development goals. “That gives people a method of meeting their impact investing goals while investing in public markets rather than in the much smaller subset of green bond issuance,” says Collinge.

So much for corporate bonds. What about the sovereign bonds traditionally beloved of insurance companies? Trickier, perhaps, but not impossible.

“At Candriam, we have a detailed methodology developed by our in-house team over a couple of decades,” says Niemczyk. “The idea is to look at both how an issuer of stocks or bonds itself performs on ESG criteria but then also to look at its exposure to worldwide ESG trends and see whether or not it will benefit from these trends.”

Another challenge is ESG reporting. A large part of what Robeco does is around helping insurance companies in terms of how they report on, for example, the CO2 emissions coming from their portfolios and water metrics. “It’s an exciting, evolving world,” says Collinge.

Whatever the challenges, ESG integration is a growing priority for insurance companies. In Europe, the European Commission put out a paper about a year ago saying that insurance companies need to have an ESG framework in place within the next two years. In Asia, China is moving towards international best practice in governance through corporate governance with Chinese characteristics.

However, integrating ESG properly requires significant resources – especially if investors want to pursue engagement strategies as part of their ESG approach. This means insurers are working ever more closely with asset management experts. “A partnership approach is how we are working with insurers on ESG,” says Niemczyk.

This article was first published in Funds Global Asia

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