Taking responsibility in investing

A year ago, Cory Anger, managing director at GC Securities, spent 1 percent of her time thinking about environmental, social and corporate governance (ESG) issues in the insurance-linked securities (ILS) sector. Now, she spends 20 percent of her time on the topic.

“We’re still in the infancy of ESG as we apply it to the ILS space. Theres’s a significant amount of opportunity to enhance these structures and communicate how they can meet the principles of sustainability and ESG goals,” she says.

Currently, many investors are focused on making sure information is collected on every ILS deal and structure on which ESG standards can be set. More defined ESG-focused questionnaires used to collate information in traditional financing and more established asset classes can be applied to this space, but it may not always work, explains Anger. The biggest hurdle, she says, is how to define what ESG means for the ILS space?

“It’s a self-sustaining process that creates more production and focuses on green initiatives.”

She adds: “We’re at a point where we need to define what ESG means when we apply it to the catastrophe bond space. We are going to hedge contingent risks that may (or may not) occur, not provide financing outright, so the industry is trying to figure out what classic ESG checklists can be applied to ILS.”

EU focus

The EU’s regulation on sustainability‐related disclosures in the financial services sector (the SFDR)—which has applied to certain financial services sector firms since March 10, 2021—has caused a significant amount of focus from the investor community on how ILS can be considered an ESG product.

“Europe is driving this discussion globally more than anywhere else, partly because of the SFDR. However, given the closeness of this capital with Bermuda, it has an impact on the Bermudian market and they have started thinking about what it means to them,” adds Anger.

According to Anger, what’s interesting with the new regulation is that it represents a change from how ESG has traditionally been promoted.

Historically, she says, when you were talking about the financing of a project, ESG was promoted through disinvestment initiatives such as “we’re not going to allow financing to be used for projects in areas we want to avoid, such as weapons manufacturing or coal”.

“Now, we are trying to promote access to capital so that we can better manage climate risk. There’s access to modelling which can provide information to all constituents and stakeholders on what the projected risk is, and this can be factored into the analysis,” says Anger.

A global approach

International financial institutions also have an interest in ESG and ILS. The World Bank first entered the cat bond market in 2009 and, since then, has issued multiple cat bonds.

In March last year, the World Bank issued four cat bonds, providing the Mexican government with financial protection of up to $485 million against losses from earthquakes and named storms for four years. GC Securities, Goldman Sachs and Swiss Re Capital Markets were the joint structuring agents and joint bookrunners for the transaction.

“By virtue of buying the capital risk notes offered by the World Bank as part of its capital risk programme, the proceeds go into the general funds and can be used for general sustainable projects,” says Anger.

She notes that there are prospects to take this opportunity further. Development banks across the world are beginning to allocate a proportion of the capital into specific “green” initiatives, rather than more general efforts.

“Some of the development banks have started to create a narrower use of proceeds, rather than just general sustainability. I think there will be more development of that type of solution,” Anger says.

This approach was used in Generali’s Lion III Re DAC catastrophe bond that closed at the end of June 2021. In addition, an amount equal to Generali’s own capital freed up as a result of the protection provided by Lion III Re DAC will be allocated to eligible projects as defined by Generali in its “Green Insurance-Linked Securities Framework”. The efforts by Generali have gone further than any other sponsor with respect to the commitment to applying green ESG principles to ILS structures.

Anger adds: “As demand grows for use of this capital, this should spur demand for green projects that a development bank is supporting. They feed on each other—we give you more capital, there are more projects to invest in, and where there are more projects, there is more capital.

“It’s a self-sustaining process that creates more production and focuses on green initiatives.”

An eye on the future

Anger is confident that the ILS market is set to grow and with it, awareness and use of ESG principles.

“This market has done nothing but grow and expand, find ways to utilise new capital and take on new risks,” she says. Anger believes there’s a lot of potential for more investor capital to come in from ESG funds.

“That capital could be meaningful to this space,” she says. “In 2021, some sponsors will place more of an ESG focus on their cat bond offering to make it more attractive to this type of investors.”

Capital for cat bonds may come via an existing ILS manager, but Anger believes that it may also come from new sources, either through the existing ILS managers that make the decision to invest in this asset class or from a direct investor that hasn’t yet stepped into the ILS space.

Anger is hopeful that this new capital will create a momentum of designing, tailoring and emphasising ESG goals and capital strategies within the ILS market.

Concluding, Anger asks: “There may be some creative uses of capital that aren’t currently thought of, and it will be exciting to see the development out of that.

“Can ESG help you embrace insurance risks that are underinsured or typically not insured at all, and find a way?”