Saving grace: how ESG-conscious ILS can help the uninsured
ILS is more than a string to the re/insurance bow—it’s a key solution to the $1.2 trillion protection gap, according to panellists at the Bermuda Risk Summit.
“ILS will be used more and more as risk is diversified and offered into the market through a capital markets vehicle.”
Greg Wojciechowski, Bermuda Stock Exchange
Once considered “alternative” capital, ILS is now inextricably linked to Bermuda’s re/insurance market. If environmental, social, and corporate governance (ESG) factors are the next seismic shift, what is the future of ESG in ILS?
That was the question posed by Greg Wojciechowski, chief executive officer of the Bermuda Stock Exchange, who chaired a panel discussion at the Bermuda Risk Summit. Other panellists were Niall Baird, managing director of Ed Broking Capital Advisors; Venetia Furbert, founder and climate risk expert at Sustenance; and Vincent Prabis, managing principal at Hiscox ILS.
Wojciechowski cited the US Sustainable and Impact Investing Trends 2020 report produced by the Forum for Sustainable and Responsible Investment. This states that sustainable investing in the US “continues to expand at a healthy pace”. The total US-domiciled assets under management (AUM) using sustainable investing strategies grew from $12 trillion at the start of 2018 to $17.1 trillion at the start of 2020, an increase of 42 percent. This represents 33 percent of the $51.4 trillion in total US assets under professional management.
“Many ILS vehicles certainly have some of the ESG criteria, which is something that has been recognised by investors around the world,” Wojciechowski said.
He referred to the 11th of the United Nations 17 Sustainable Development Goals, which is to make cities and human settlements inclusive, safe, resilient and sustainable.
“One of the specifics of Goal 11 is a substantial increase in the number of cities and human settlements adopting and implementing integrated policies and plans for inclusion, resource efficiency, mitigation, adaptation to climate change, resilience to disasters, and developing and implementing holistic disaster risk management across all levels,” he said. “ILS is clearly a vehicle that can help reach this goal.”
He gave two examples of ILS securities cat bonds that have “touched the ESG mark”.
In 2017, Generali announced its return to the ILS market with a €200 million cat bond on floods and windstorms in Europe and earthquakes in Italy. The transaction was the first European multi-peril indemnity-triggered rule 144A catastrophe bond.
“The transaction was the first ILS issuance that embeds innovative green futures and compliance within the Generali green ILS framework,” Wojciechowski said.
The second example was the first parametric cat bond to cover pure volcanic eruption risk, which was brought to market for the Danish Red Cross in March 2021. Listed in Guernsey on The International Stock Exchange, it was the first cat bond with a purely humanitarian-focused payout strategy.
Of particular interest, Wojciechowski said, was that the notes were settled using a blockchain-based ILS platform (ILSBlox). “This was a deal that was predicated on the use of blockchain technology,” he added.
More than an acronym
Turning to Furbert, Wojciechowski asked for a “reminder” of what ESG is, and how ILS can support climate change, adaptation and enhancing community resilience.
“I like to think about ESG as moving the financial decision-making process from a band perspective, to an orchestra,” Furbert said. “We have more voices in the room and more factors to consider.”
“One important thing to notice is that incorporating ESG factors isn’t at the cost of generating a financial return. Instead, it’s with the expectation to improve that return,” she added.
The “most mature pillar” of the environmental part of ESG is climate risk, she said, but there are other pillars, including natural resource management.
The social factor means a firm changing its outlook from purposing its work towards creating value for shareholders or institutional investors, to a more “stakeholder-aware approach”, she said.
Good governance includes aligning compensation with the incentive not only of shareholders, she said, but of stakeholders as well. An example of how ILS could improve resilience is in supporting “climate-smart agriculture enhancement”. Furbert referred to the “Global South”—the regions of Latin America, Asia, Africa and Oceania—which are expected to be the most heavily impacted by climate change.
“It is important not merely to observe the impacts, and projected impacts, for the transfer of risk, but to support the transfer of risk knowledge, which will help improve resilience,” she explained.
The world’s uninsured
Citing research by Swiss Re, Wojciechowski reminded delegates of the large protection gap in total uninsured losses. In layman’s terms, those stem from the people across the world who have no insurance, in many cases because they can’t afford it.
The Swiss Re Institute’s Resilience Index 2020 showed that the global protection gap had risen to a record high of $1.2 trillion, with the biggest gaps in health and mortality protection, as well as natural catastrophe cover. The insurance gap remains smallest in North America and biggest in the Asia-Pacific region.
Wojciechowski asked Prabis whether an “ESG-conscious” ILS sector could help close that global protection gap. Prabis said the Danish Red Cross cat bond was “extremely innovative investing for a peril that was not covered by traditional reinsurance”.
“There is an appetite from ILS investors for more diversification that they do not get in the same way that most insurers and reinsurers do. The Danish Red Cross example reminds us that, as an ILS investor, typically you’re participating in only a subset of the traditional insurance and reinsurance spectrum.
“Within that subset, mostly cat, you are constantly looking for diversification. So there’s a genuine search for diversification. But, of course, the social aspect of a bond like this one reinforces the role of ESG,” he said.
“We mentioned the Red Cross, but we can also talk about the World Bank which, over the last 15 years, has been a very active issuer of cat bonds. Most of them are parametric but, most importantly, most of them offer coverage where the traditional insurance and reinsurance industry does not participate.
“That’s possibly because the local insurance market is not mature enough and maybe because some of the peril that needs to be covered doesn’t really work on the Unified Modelling Language on an indemnity basis, so we’ve seen an increase in parametric bonds issued by those participants.
“Yes, we believe ILS will have a role in bridging the gap, and that is in great part thanks to the ESG focus that our industry has.”
Wojciechowski suggested that ILS had proved to be “a palatable security that the capital markets can consume”. ILS will be used more and more, he added, as risk is diversified and offered into the market through a capital markets vehicle.
Beyond environmental
Wojciechowski asked Baird whether the insurance and ILS industries were “overly myopically” focused on the environmental part of ESG, and not paying sufficient attention to the social and governance parts.
“In short, yes—but to pick up on Venetia’s point earlier, we think of ESG as doing good by doing good,” Baird said. “ESG is all sorts of useful information and all sorts of useful impetus for encouraging change.
“If you think about what that means for the industry and ILS within the ‘S’ and ‘G’, the industry should give itself a pat on the back: it was the first major industry to get there in terms of understanding that manmade global warming was a thing.”
To the point that many of those who are most impacted by climate change are also those least able to afford insurance, parametrics are a way to reach “those with exposure but currently with no cover at all”, he added.
He also noted Natural Disaster Fund (NDF) Deutschland that was formed in 2019 by Global Parametrics (a provider of parametric protection against climate risks in developing markets), Germany’s Federal Ministry of Economic Cooperation and Development, German bank KfW, and the UK Department for International Development (now the Foreign, Commonwealth & Development Office). This followed, and partnered with, NDF UK, which was launched in 2018.
“If what those two governments did were replicated everywhere else, there would be billions of dollars of limit that doesn’t exist at the moment,” Baird said.
Inclusive insurance
Wojciechowski referred to the World Bank programmes that are making insurance accessible to some of the underinsured, and going through aid agencies to bring coverage to people who otherwise wouldn’t have it.
“There’s a huge drive in the insurance space to broaden access to products, and not just on the industry side, but also on the innovation side,” Furbert said.
Referring to her participation in the October 2021 International Conference on Inclusive Insurance, she recalled discussions between regulators in Uganda about the innovation projects they have.
“If we connect those two sides—industry and innovation—and see the developments that are happening at that level, we can develop the products—mainly parametric-triggered products—that can cover those exposures in an efficient way. And it adds a diversification element to portfolios,” she explained.
“When it comes to climate-related risk, it would be great to have that geographical diversification, and that could possibly, at the portfolio level, ameliorate any concerns on returns.”
Prabis noted that parametric products will mostly be used, but that in many of the places where that coverage is needed, such products don’t yet exist, and the traditional insurance industry is often lacking.
“Being able to bypass that through innovative technology-based solutions is going to help as well,” he concluded.
