Appealing to the ESG crowd

Insurance-linked securities (ILS) has an opportunity to reach a new class of investor by doing more to market its credentials as an environmental, social and corporate governance (ESG)-friendly product, according to Tom Libassi, co-founder and managing partner at ILS Capital Management.

“I don’t see much evidence that people invest in ILS because it is an ESG product,” admits Libassi. “But I see a lot of evidence that people who do invest in ILS see it as an ESG product. In short, there is a growth opportunity there.”

Libassi notes that, for now at least, ESG seems to be a bigger deal in Europe than in the US, but he believes this is beginning to change. As a growing number of US-based investors start looking at socially responsible investing, that could drive increased interest in ILS—particularly if issuers and sponsors do more to play up the social benefits that these products deliver.

“ILS is a social, rather than an environmental product,” says Libassi. “It is often the poorest neighbourhoods that are most affected by hurricanes.”

He argues that ILS could also do more to roll out solutions such as parametric triggers to regions that are exposed to these kinds of risks.

“It is a good way for governments to get cash into the hands of the people who are affected by these disasters,” he says. “The insurance gap is huge, and the industry’s priority has to be finding ways to close it. There is money to be made in doing that but there is also a considerable social good in providing coverage to people who live in catastrophe-prone areas.”

“Renewable energy projects usually need an offtake agreement, and this is where insurance can play a role in terms of ESG.”

Investor concerns

Libassi is more sceptical about the prospect of ILS stepping up efforts to appeal to ESG investors by investing ILS collateral into securities that would appeal to those people, because that would probably be riskier than the US Treasuries they typically hold.

In 2008, cat bonds were trading at a discount which meant the collateral was at risk, but since then the market practice around collateral and how it is invested has changed. For collateral to do its job, it is important that it is invested in extremely low risk and liquid securities.

“On the reinsurance side, we’re rather limited in what we can do in the ESG space with respect to collateral management,” says Libassi.

“It is hard to see counterparties agreeing to having the collateral invested in renewables or lower-rated ESG securities if it means they have to post 120 percent collateral or may be called on to invest top-up collateral.”

In terms of investments, reinsurers are more constrained by insurance providers’ ESG programmes, says Libassi. “There are certain areas where we can participate, such as reinsuring renewable energy deals, but in the treaty space we don’t get much opportunity to pick and choose. The market is dominated by a few players and we have to work with the deals that are out there.”

There are more opportunities in ESG on the insurance side, he says. “Insurers are developing new cat and flood models and addressing the carbon markets. There are potentially good rates of return to be made in the ESG-insurance space, and they are generally uncorrelated with other financial assets.”

Priorities

Libassi believes the re/insurance community and wider society needs a debate about its priorities in the ESG space, what it wants to achieve and what role re/insurers should play in bringing that about. That would help the industry develop a new generation of products that provide appropriate coverage in line with the goals that companies and governments want to achieve.

“Should ‘green’ bonds be issued to finance projects such as the construction of barriers to protect Houston from hurricanes?” asks Libassi. “If so, should these bonds be sold at below the market rate to insurance companies to cover losses from future earnings?

“We could see ESG liability and carbon-cover products that insure companies against failing to meet their ESG objectives, as well as green insurance to ensure green targets are met and can be used to buy carbon credits if they aren’t.”

One example of the dilemma that can come about when using financial products for ESG purposes is perfectly illustrated by flood insurance. It is possible to take diametrically opposing views on this subject, even while looking at the issue from a specifically ESG perspective.

“Insurance should encourage positive behaviour, and helping people rebuild their homes after they have been destroyed is a social benefit,” notes Libassi. “On the other hand, should we be encouraging people to build on floodplains? The decision to subsidise $2 million homes via flood insurance is a social issue, but there is an opportunity to improve the flood insurance market for the general population.”

Insurers have done a lot of work with renewable energy companies to help them get off the ground and make sure that they are financially viable, and Libassi believes this could also provide a model for flood insurance.

“Renewable energy projects usually need an offtake agreement, and this is where insurance can play a role in terms of ESG,” he explains.

“Flood insurance could work in a similar way, providing coverage as long as flood protection is built to meet certain requirements. Currently, the industry isn’t really set up for this approach, but it could evolve that way if that were what the market needed.”

More clarity from governments about their ESG goals would also provide an opportunity for the industry to resolve the taxonomy issue, to standardise terms and best practices and give investors greater confidence that ESG products are consistent with regard to their standards and approach.

“Work is being done to resolve the taxonomy issue, although it relates more to the social and corporate governance aspects than the environmental components of ESG,” says Libassi.

“Historically it has been predominantly a question of exclusions—about what you don’t invest in or who you don’t do business with. This exclusionary approach partly arose from the earliest ESG investors who tended to be religious institutions with a focus on social and governance concerns such as guns, pornography or gambling.

“There is a great opportunity to take a more active approach to ESG issues, particularly in the insurance space,” he concludes.