ESG: why size matters

By any measure, 2021 was a bumper year for investments focused on environmental, social and corporate governance (ESG) issues. According to financial analyst Lipper, global flows into ESG funds in 2021 hit $814 billion. Total assets grew 17 percent to pass $7 trillion.

Sustainable bonds issuance—traditionally the poor relation in ESG finance—hit $1 trillion, up 45 percent and a 20-fold rise since 2015. They now account for 10 percent of global debt markets.

As the panellists in Intelligentinsurer.com’s discussion of the issue agreed, that has been felt across the insurance industry. And it’s not wholly new. Jessica Botelho-Young, associate director of analytics at AM Best, recalls that even two years ago, a survey by the agency of its European and Asia-Pacific-rated businesses showed more than half already integrating ESG factors into their investing activities. A further 15 percent said they intended to start considering ESG criteria in their investment approach within 12 months.

More than half (56 percent) also agreed that re/insurers had a pivotal role to play in steering the ESG agenda.

That was no surprise to the other panellists: Dan Topping, chief investments officer at BP Marsh; and Gerald Chen-Young, principal at specialist global institutional investment management, consulting and advisory firm GCY Associates.

Topping notes similar findings from a recent survey of Lloyd’s managing agents about ESG integration in investments. For Chen-Young, meanwhile, there’s a sense of inevitability.

“ESG is a movement not dissimilar to universal suffrage, anti-slavery, anti-whaling, anti-smoking, and so forth. Like most movements, it began grassroots but eventually evolved, and I believe that we are going through this evolutionary stage of ESG,” he said.

“We believe it’s here to stay.”

Exclusions and engagement

In some important ways, however, progress is still limited. As AM Best’s survey put it, there remains “a marked lag between recognition of ESG risks and action being taken to mitigate those risks”.

This is true for investments—in terms of those still not considering ESG and also of the sophistication of existing approaches.

As Botelho-Young points out, insurers’ most common approach to ESG investment remains negative screening—at its simplest, refusing to invest in typical “sin stocks” such as alcohol, tobacco, gambling, and weapons. Others are taking a “more nuanced” approach, using either internal or external ESG ratings and data, harnessing voting rights and engaging with businesses they invest in to drive improvement.

“The engagement approach gives companies the chance to change their behaviours rather than lose an investor,” she explained.

It’s more striking, however, when it comes to the other side of insurers’ business. As Botelho-Young explained, re/insurers occupy a unique position when it comes to ESG, as both risk managers and institutional investors.

“ESG factors have the potential to affect both sides of the balance sheet,” she said. “It highlights the importance of integrating ESG factors into both underwriting and investing activities.”

So far, most re/insurers’ adoption of ESG has been distinctly uneven. As Topping put it, with investments, integration of ESG issues is quite advanced, “whereas on the underwriting side it is probably still lagging”.

The need for standards

Change will come, and it will be driven across a number of fronts.

One will be the rating agencies themselves. AM Best, for instance, has since 2018 included a section on ESG risks and how they can impact contributors to the credit rating analysis: balance sheet strength; operating performance; business profile; and enterprise risk management.

Chen-Young expects that to intensify. “ESG is going to become part of the calculus in discerning and prioritising credits. It’s not there yet; it’s nascent, but it is coming,” he said. Regulation, too, is likely to drive companies to greater consideration of ESG.

“I believe that ESG is eventually going to find its full force in annual audits,” said Chen-Young, with regulators in the UK and the US requiring companies to comply or at least explain deviations from accepted standards.

“These bodies are going to enforce and enjoin companies—especially public companies and custodians of public monies such as pension funds—to meet certain measures of good governance and related ESG measures,” he explained.

That, however, requires accepted standards to be in place. So far, that’s lacking even for investments, let alone underwriting.

“Data is so nascent that there isn’t one set of guidelines or agreed parameters for rating agencies or others,” said Topping.

Botelho-Young agreed: “The data we are currently using is largely unaudited and self-reported, so there can be inconsistencies in the reporting and disclosure,” she said. “That’s a real challenge.”

In part, increased regulatory interest will help address that: developments such as the EU Taxonomy Regulation for sustainable activities, which provides a green classification system translating the EU’s climate and environmental objectives into criteria for specific economic activities, point the way ahead.

But it will also be down to the industry to develop and define best practices, particularly the larger companies.

“It is a challenge, especially at the smaller end where you don’t have the infrastructural bench strength,” said Topping. “The insurance sector needs the bigger players to be out in front doing things to educate the wider sector on what to disclose and what best practice looks like. Then that can permeate through the rest of the sector on the underwriting side.

“As an industry, we probably need that top-down approach from the bigger companies,” he concluded.