The case for ESG investing and its adoption by P&C insurers
Investors new to this space would be well served to partner with an expert who can help them navigate the landscape.
Environmental, social and corporate government (ESG) investing has been getting a lot of airtime lately. Interest and engagement in ESG and its role in portfolio construction has increased among insurers, particularly P&C insurers.
Historically, ESG focus has been on the non-fixed-income/surplus side of the general account. This asset class was the first to generate ESG-based portfolio construction considerations. But more has since been done on the fixed income side, and this has expanded interest from insurers who invest the majority of their assets in fixed income.
The usual approach taken by insurers new to this area has been to initially figure out the most appropriate ESG framework under which a carrier would manage portfolios, then identify the various nuances and how they impact decision-making. Learning how the landscape has evolved over the past couple of decades is also helpful background for insurers new to ESG.
One headwind faced by insurers new to ESG when developing a suitable investment framework, however, is the lack of harmonization and standardization available. There are many different approaches to setting up an ESG framework, and investors new to this space would be well served to partner with an expert who can help them navigate the landscape.
Historical analysis has demonstrated the case for incorporating ESG into portfolios. The thesis is that ESG investing is not only a morality tale but also can generate long-term outperformance. In particular, more sophisticated insurers are looking at ESG as less of a “screen for sin” and more of an opportunity to actively engage with companies held in their investment portfolios and provide additional levers to help augment risk-adjusted returns.
As ESG moves further into the crosshairs of P&C insurers’ investment considerations, the drivers behind this shift appear to be coming from several sources.
Certain states such as California and New York have been increasing their regulatory focus on ESG, and insurers domiciled in those states have taken note. Further, regulator- and government-led considerations may increase as the new administration openly flags their intentions to champion and promote ESG policies, e.g., rejoining the Paris Climate Change Accords. Insurers are likely to sense regulatory headwinds and try to stay one step ahead from a competitive perspective.
Perhaps due to the threat from global warming, California wildfires or hurricane-induced flooding in Houston, it feels like there is a constant stream of environmental challenges and disasters occupying the media. This exposure is a tailwind for insurers looking to incorporate environmental considerations within both their operations as well as their investment strategies.
Insurance regulators are also beginning to issue reporting requirements for insurers as part of their Own Risk and Solvency Assessment (ORSA). The primary tool that is being proposed for quantifying these risks is scenario analysis (i.e., stress testing) because it allows insurers to investigate the effects of many possible outcomes without the need for assigning a specific probability to a scenario. (Conning has developed a capability to meet this need).
In addition, pressure to address ESG elements in investments is mounting from shareholders, particularly those looking to put ESG issues on the corporate agenda and forcing corporate decision-makers to at least benchmark their investment portfolios against ESG considerations. Most shareholders understand the risk of not acting is at the very least reputational and one that is best avoided.
The question of corporate responsibility is not lost on insurers that are fundamentally in the business of financially protecting their customers. The social good stemming from such protection can be expanded to cover other aspects, most notably, that of ESG within investment holdings and beyond.
We have also observed certain insurers viewing ESG as a marketing opportunity in terms of attracting a certain kind of customer (e.g., millennials) who value and look favorably upon businesses considering ESG issues and acting upon them.
European insurers appear to be leading the way in relation to ESG and incorporating such considerations on an enterprise-wide basis. Although insurers on this side of the Atlantic may have some catching up to do, a combination of the factors noted in this article may help close the gap faster than many might realize. Notably, in December 2020, Liberty Mutual became the first U.S. P&C insurer to become a signatory to the United Nations’ Principles for Responsible Investment (PRI).
ESG considerations, as they relate to investing within the general account, are a straightforward starting point to then broaden out such considerations to an enterprise-wide approach. Indeed, certain insurers have already done so by incorporating ESG issues (e.g., climate change) directly into the underwriting process. The United Nations’ Environment Program Finance Initiative Principles for Sustainable Insurance is a ground-breaking resource that looks at these aspects further.
Indeed, the ESG-related skills developed by asset managers can be utilized in other parts of an insurer’s business, from underwriting to claims management and the operational aspects of the business, on an enterprise-wide basis. Many asset managers are already supporting their insurance company clients in doing so.
Sean Kurian, FSA, CAIA, FIA, FRM, is a managing director and head of Institutional Solutions at Conning, an investment management firm. For more information, call (888) 266-6464.
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