ESG INVESTING: THE TIDE IS COMING IN FAST

The prominence of sustainability and corporate social responsibility has led to increased investor awareness about more ethical participation in the market, and the trend is growing fast for the captive insurance industry, says Gregory H. Cobb of Sage Advisory Services.

Innovative. Flexible. Progressive. Ever-evolving. For more than 50 years, the captive insurance industry has been the undeniable center for the world of alternative risk transfer. Captives drive opportunities for parent organizations in the achievement of overall corporate objectives, ensure the ready access to capital, support individual business units, and protect human capital. Throughout this journey and as participants know all too well, the captive insurance industry has been no stranger to controversy.

In the somewhat more staid world of investment management, environmental, social, and corporate governance (ESG) investing has become one of the most discussed and at times controversial approaches to investing that the industry has seen in decades. However, through it all, ESG investing has significantly expanded globally as industry participants and investors increasingly recognize the interdependence of environmental, social and economic risks, and that ESG analysis can uncover risks and drive investment performance.

The insurance industry has recognized that the world is facing increasing ESG-related challenges. This changing risk landscape is leading to the rise of more diverse, interconnected and complex coverages. We are seeing the insurance industry (particularly reinsurers) rapidly adapt and adjust the range of risk factors considered in managing their businesses, with ESG issues increasingly influencing traditional risk factor analysis. As such, the industry is adopting a more holistic and far-sighted risk management approach in which ESG issues are considered. As risk carriers, risk managers, and investors, should we expect any less?

The captive insurance industry is well-suited for the innovative management of increasingly complex risks and well-versed in embracing controversy. To date, few ESG initiatives can be attributed to the space, but there are some first movers. The Bermuda Business Development Authority (BDA) announced its initiative to establish Bermuda as the world’s climate-risk finance capital with the Association of Bermuda Insurers and Reinsurers (ABIR) quickly pledging support.

It is Guernsey, however, that has taken the lead in the captive insurance space with its introduction of an ESG framework for insurers. It was designed by the Guernsey International Insurance Association (GIIA) with the goal of assisting member organizations in their management of ESG risks and opportunities for the delivery of positive ESG impact.

The framework enables member organizations of GIIA to self-certify and apply for a kitemark through a third party accreditation process. How soon will it be before other domiciles incorporate even partial adoption of basic ESG principles, accreditation, and reporting?

There is no question that the tide of ESG is rising fast for the captive insurance industry. There are a few boats in the water, but the opportunity to truly prove the flexible, innovative, progressive, and ever-evolving nature of the captive insurance industry still lies ahead.

The tide that is ESG

ESG investing (related investment approaches include “socially responsible investing”, “impact investing” and “sustainable investing”) prioritizes optimal ESG factors or outcomes in the investment process. ESG investing is widely seen as a way of investing “sustainably”—where investments are made with consideration of environmental and human wellbeing as well as economic impact. It is based upon the growing assumption that the criteria for a company’s financial performance are increasingly affected by ESG factors.

Environmental: What kind of impact does a company have on the environment? This can include a company’s carbon footprint, toxic chemicals involved in its manufacturing processes, resource depletion, and sustainability efforts that make up its supply chain.

Social: How does the company improve its social impact, both within the company and in the broader community? Social factors include everything from LGBTQ+ equality, racial diversity in the executive suite and staff overall, and inclusion programs and hiring practices. It even looks at how a company advocates for social good in the wider world, beyond its limited sphere of business.

Governance: How does the company’s board and management drive positive change? Governance includes everything from issues surrounding executive pay to diversity in leadership as well as how well that leadership responds to and interacts with shareholders.

The principles of ESG investing are nothing new. Hundreds of years ago, religious and ethical beliefs influenced investment decisions. Muslims established investments that complied with Sharia law, which included prohibitions on weapons. The first ethical unit trusts in the US and UK were developed by Quakers and Methodists. Today, the growing prominence of sustainability and corporate social responsibility has led to increased investor awareness about more ethical participation in the market.

With global institutions such as the United Nations (UN) now directly promoting greater awareness of sustainability, ethical standards, and social responsibility, insurers are sitting up and taking notice of the concerted call for ESG principles to be adopted. The UN has founded or sponsored a number of ESG initiatives relevant to the insurance industry, with the number of firms having adopted them significantly rising in recent years:

• The Principles for Responsible Investment (PRI) were established in 2006 with Munich Re and Aviva as founding signatories. Supported by the UN from its inception, the PRI include a commitment to promote and incorporate ESG principles in the investment process while maintaining transparency in decision making. Since 2006 PRI membership has grown to over 4,300 signatories with almost exponential growth in the last five years (Figure 1).
• The Principles for Sustainable Insurance (PSI) initiative was launched in 2012 and comes under the umbrella of the UN Environment Programme Finance Initiative. It defines sustainable insurance as “a strategic approach where all activities in the insurance value chain are done in a responsible and forward-looking way by identifying, assessing, monitoring and managing risks and opportunities associated with ESG issues”. The PSI are motivated by the fact that as risk managers, risk carriers, and investors, insurers can play a vital role in encouraging sustainable economic development. In 2020, the PSI published its newest guide on how to integrate ESG practices into global insurance at the enterprise level.

While these initiatives have been active for a number of years, they have seen significant uptake only within the last few. The reasons for this are many and varied, but rising and significant pressure for action from investors and regulators are key factors. With this, reinsurers (particularly European) have consistently stood at the vanguard of the insurance industry’s efforts for the consideration and integration of ESG factors across the enterprise.

In a 2021 report (“Investor Pressure Adds Momentum for Reinsurers to Integrate ESG Factors”), AM Best notes that major global reinsurers consistently “boast publicly available sustainability policies covering investments, underwriting and internal corporate behavior”. They cite:

Munich Re: A self-described “pioneer in analyzing the impacts of anthropogenic global warming and natural climatic variability on losses caused by weather-related natural disasters”, the company has a 40-year history of researching risks, loss prevention measures, and developing new risk-transfer solutions.

Swiss Re: A focus on sustainability seeks to identify and address the challenges that threaten stable long-term development. This translates into offering protection against such risks where viable and supporting efforts to reduce them and prevent them (adaptation and mitigation).

Hannover Re: The company is committed to establishing a framework for integrating ESG criteria into its underwriting policy for facultative reinsurance by 2023. In addition, it has ceased writing new policies for individual risks in coal-fired power plants or mines for thermal coal.

Lloyd’s: The company provides guidance to all managing agents to hit its target of 2 percent of annual premiums on innovative and sustainable products by year-end 2022. Effective January 2022, managing agents are no longer providing new insurance coverage to thermal coal-fired power plants, thermal coal mines, oil sands, and new Arctic energy exploration, with all existing coverage phased out by 2030.

Figure 1: UNPRI signatories

More than 4,300 investors worldwide have signed the Principles for Responsible Investment

Figure 2: ESG Incorporation/Stewardship & Active Ownership

AM Best notes that consideration of ESG factors has grown significantly across the insurance value chain. Changes in reinsurers’ attitudes and behaviors, driven by increased ESG integration, are a primary source of growing pressure for all insurers and risk-bearing entities, particularly for the laggards in the adoption of basic ESG principles.

The adoption and integration of ESG by insurers can be a complex process as there is no one approach that serves as a guide. It is not a plug-and-play proposition. However, most insurers typically use a combination of two overarching approaches: ESG Incorporation and Stewardship & Active Ownership (Figure 2).

How ESG investing develops within a company will be shaped in large measure by the internal culture of risk, purpose-driven agendas proposed by boards of directors, resource capabilities of senior management teams, and the ensuing demands of stakeholders (policyholders, shareholders, consumers, employees, regulators).

As ESG investing and sustainable approaches mature with the ongoing development of international standards and best-practice frameworks, insurers will be better able to build the optimal framework specific to their company. For each company, this journey will promote not only a greater awareness of ESG risks but also ESG opportunities, and in the end, further enhance the value proposition for the enterprise as a whole.

This article is for informational purposes only and is not intended as investment advice or an offer or solicitation with respect to the purchase or sale of any security, strategy or investment product. Although the statements of fact, information, charts, analysis and data in this report have been obtained from, and are based upon, sources Sage believes to be reliable, we do not guarantee their accuracy, and the underlying information, data, figures and publicly available information has not been verified or audited for accuracy or completeness by Sage. Additionally, we do not represent that the information, data, analysis and charts are accurate or complete, and as such should not be relied upon as such. All results included in this report constitute Sage’s opinions as of the date of this report and are subject to change without notice due to various factors, such as market conditions. Investors should make their own decisions on investment strategies based on their specific investment objectives and financial circumstances. All investments contain risk and may lose value. Past performance is not a guarantee of future results.

Sage Advisory Services is a registered investment adviser that provides investment management services for a variety of institutions and high net worth individuals. For additional information on Sage and its investment management services, visit www.sageadvisory.com

Gregory H. Cobb is director of insurance solutions at Sage Advisory Services. He can be contacted at: gcobb@sageadvisory.com