Ethical investing, make money—but be ethical too

The investment performance of re/insurers varies widely. At one end of the scale are the ultraconservative strategies of the bigger, traditional players; at the other, the more risky strategies of private equity-backed companies, some of which see the business of underwriting as merely a way of accumulating a “float” which they then invest.

Whichever end of the scale you look at, the strategies of re/insurers are increasingly being influenced by something other than simply risk versus reward. More investors are putting pressure on companies to invest in an “ethical” manner one that takes into account the wider implications of how that money will be used, and its effect on society.

In the past some re/insurance companies may not have cared much about where their profits came from, as long as they were profitable. Those times are now largely gone, thanks to the rise of pressure groups who ask awkward questions about where investment profits come from, and whether they are ethical in terms of social or other matters.

This logic is increasingly being seen targeting both sides of the balance sheet. A good example is the Unfriend Coal group that has been pressuring insurance companies to stop insuring new and existing coal projects, on the basis that the burning of coal releases large amounts of carbon dioxide and contributes to global climate change.

At the May 2019 meeting in Buenos Aires of the Geneva Association, an insurance industry think-tank involving the CEOs of the 80 largest insurance companies, protestors from Unfriend Coal and Greenpeace urged the insurers to stop covering coal-related projects.

A shift of emphasis

There has been some movement recently away from traditional investments towards greener, more ethical, investments. In March the Association of British Insurers (ABI) claimed that the insurance industry is putting forward ideas to make it easier for the financial sector to invest in greener assets, unlocking billions of pounds’ worth of funds which could help mitigate the global impact of climate change.

According to the ABI, the UK’s insurers alone hold over £1.8 trillion in invested assets, plus there are many trillions more managed by investment firms and banks. However, the ABI also pointed out that at present, only around 1.2 percent of all assets under management in the UK are invested in greener projects such as renewable energy, collectively known as environmental, social and governance (ESG) assets.

The ABI claims that a number of obstacles prevent insurers and other asset managers from increasing this proportion, notably:

There is a shortage of high-quality and consistent ESG data throughout the financial system, making it difficult for investors to either manage their exposure or identify the best opportunities for green investment; and with its focus on a one-year solvency measure, the current prudential regime for insurers doesn’t adequately reflect the long-term nature of insurance. The Solvency II rules effectively disincentivise insurers from investing in the kind of long-term, sustainable projects that could help mitigate the impacts of climate change.

The ABI has therefore proposed ways to address these issues in a consultation response to the Prudential Regulation Authority (PRA), while also supporting proposed Financial Conduct Authority guidance to increase the consistency and comparability of climate change-related financial disclosures.

On data availability, some insurers are developing their own approaches and specialist teams but it’s feared a piecemeal approach will take an unnecessarily long time. Instead, the ABI says, there is a role for the regulators to play across the full breadth of the financial sector to help improve the availability and consistency of data relating to the firms and initiatives insurers may want to invest in.

Factoring in sustainability

Looking at the regulatory regime, the ABI is proposing more is done to take sustainability factors into account when considering assets, particularly given the good match between longer-term investments and insurers’ long-term liabilities.

Enabling this should be a key focus of the Solvency II 2020 review which is just getting under way, and is something the UK could take steps on independently if and when the UK’s departure from the EU happens.

In March Steven Findlay, head of prudential regulation at the ABI, said: “Insurers are more aware than most of the increasing threat posed by climate change, given they are in the business of identifying future risks and working out how best to mitigate them.

“When extreme weather events happen, they are at the forefront of picking up the pieces. As a sector which holds over £1.8 trillion in invested assets, they are also in a unique position to be able to seriously boost new, greener technologies and energies. They want to be able to do more of this, and it is very encouraging that the PRA shares these goals.

“Moving our world towards a lower carbon economy is in the interests of everyone, which is why we are setting out some steps to help unlock billions of pounds of investment for innovative, greener projects.

“We have to be practical about what will make a difference. Those responsible for managing assets need to be able to demonstrate to their boards and their shareholders that greener investments are good for their balance sheet, not only the planet.

“The industry, through initiatives such as the recent ClimateWise Transition Risk Framework, is already taking positive action; regulatory changes to give insurers more freedom to invest in sustainable assets would also be a step in the right direction.”

Some companies have already identified this as an important area to identify and invest in.

In a statement Zurich said that it is committed to making up to $5 billion in impact investments. Achieving this level, will, it believes, avoid five million tonnes of CO2-equivalent emissions per year, and separately, make a positive contribution to the lives and livelihoods of five million people.

Zurich said that it evaluates impact investments within the context of specific asset classes and creates dedicated strategies for impact investments within those classes. While continuing to make systematic use of ESG data in investment decision-making, it will look at a variety of ways to grow its impact investment portfolios around the world.

Zurich has announced that it will focus on the following asset classes:

Green bonds: according to Zurich the green bond market has shown impressive growth over the past several years. It expects its green bond portfolios to continue growing beyond the $2 billion mark the milestone it said it reached in August 2017. As of December 2018, Zurich had invested $2.7 billion in green bonds.

Social/sustainability bonds: with the introduction of the Social Bond Principles and the Sustainability Bond Guidelines, the company said it is seeing increased opportunities in the social and sustainability bond space. As of December 2018, Zurich had invested $425 million in social and sustainability bonds.

Impact private equity: the company said that it will keep working toward its 10 percent impact target in private equity.

Impact infrastructure private debt: including direct private debt lending towards infrastructure such as solar/wind farms and social institutions.

Zurich said that it will evaluate new prospective opportunities across asset classes to broaden the approach and increase the investment volume.

It added that its impact investment portfolio grew from $2.8 billion in 2017 to $3.8 billion in 2018. The portfolio includes green bonds, as well as social and sustainability bonds, and commitments to six private equity funds active in areas such as financial inclusion and clean technology.

Tracking success

For the first time, Zurich has included its private debt impact infrastructure investments as an asset class, which required a common definition of an “impact infrastructure”. In 2018, Zurich developed an impact measurement framework to track the success of its impact portfolio.

Zurich said that it is proud that a pilot study of the majority of its impact investments revealed that it helped to avoid 3.4 million tonnes of CO2-equivalent emissions and, separately, improves the lives of 2.4 million people annually, as of December 2018.

“On top of tracking our exposure and targeted returns, we want to know what each of our investments achieves in terms of impact, and to measure our contribution toward our impact investment objectives: mitigating environmental risks and increasing resilience,” Zurich stated.

“Measurement helps us make better investment decisions and allows us to communicate our value to our shareholders. It also demonstrates that financial returns can be balanced with environmental and social returns.”

When committing to specific impact targets as the first private sector investor, Zurich says that it deliberately chose to challenge itself and the market to develop a methodology that allows it to measure impact on portfolio level across asset classes and underlying investment instruments.

Zurich adds that the impact measurement framework it developed allows it to aggregate the impact across Zurich’s impact portfolio in terms of two defined impact metrics: “CO2-equivalent emissions avoided” and “the number of people who benefited”.

Data on emissions of greenhouse gases (generally quoted in tonnes of CO2-equivalent emissions) is a commonly used indicator to assess the climate impact of an asset as established by the International Financial Institutions’ harmonised framework.

“Avoided” CO2 emissions are calculated against a baseline scenario that reflects the most likely project outcomes or level of service achieved in the higher-carbon status quo of the economy.

To measure its social objective to “increase resilience”, Zurich counts the number of people who have benefited from its investees’ services in education, housing or financial inclusion and other measures aimed at improving lives. In addition, in its measure of “the number of people who benefited”, it only counts those individuals who are part of a specific targeted audience of people, and were previously unable to access those services.

Zurich’s impact framework methodology looks only at the impact created by Zurich’s share of investments and is based on the information reported by the issuers of impact investing instruments.

The scope of the pilot study encompasses 70 percent of Zurich’s green bond portfolio, 70 percent of its social/sustainability bond portfolio, as well as the impact private equity portfolio and the Swiss real estate activities.

According to Zurich, the results of its pilot study show that the company is well on track to achieve the targeted impact goals of avoiding five million metric tonnes of CO2-equivalent emissions and improving the lives of five million people per year.

Green and sustainable

Allianz has also been looking at greener investments. According to Allianz, whether providing insurance or investing its customers’ insurance premiums, the company considers the ESG risks associated with such transactions.

It has stated that it aims to lead the insurance industry in integrating ESG factors into its insurance and investment businesses and that all of its ESG integration activities are implemented through group-wide corporate rules on risk management, underwriting and investment.

According to Allianz, ESG factors are extra-financial factors that can influence, and be influenced by, its business activities. If not addressed appropriately they can escalate into substantial risks.

The company has stated that examples of ESG risks include human rights violations, illegal logging activities, or severe corruption allegations, and that it diligently manages ESG risks to ensure they don’t develop further.

It has also stated that alternatively, ESG factors can present opportunities to induce positive change, such as increased requirements for renewable energy investments or offering solutions for emerging markets.

Swiss Re is another company that makes clear it has a corporate responsibility policy. In its 2016 Corporate Responsibility Report, Swiss Re stated that sound risk management is essential for a re/insurer and that tight control of its exposures guarantees that it can fulfil its role in society as ultimate risk-taker and be a reliable partner to its clients when they need the company.

The core categories of its risk landscape comprise insurance risk (property and casualty, life and health) as well as financial market and credit risk. In addition, it considers it essential for a responsible company to pay attention to further significant risks it may be exposed to, especially in the longer term.

In the report the company stated that sustainability, political, regulatory and emerging risks are particularly relevant in this respect. It claims to have developed instruments and know-how that help it to identify and assess all of them. This therefore allows it to determine the specific risks it thinks it should avoid because of their loss potential, or for ethical reasons, or both.

“This extended risk awareness is also key to managing our assets responsibly,” the Swiss Re report said. “The risk assessments we make through our Sustainability Risk Framework, in particular, flow directly into our investment decisions.

“We define sustainability risks as ethical concerns related to potential environmental and socioeconomic impacts of our business transactions, and the reputational risks they may entail.”