Fidelity International’s research team spent four months analysing the sustainability credentials of insurance company portfolios. We found that there was a spectrum of attitudes towards sustainability, leaving some companies more exposed to ESG risks than others. We incorporated our findings into our in-house sustainability ratings criteria, with longer-term implications for insurers who continue to neglect sustainability issues. 

Adapting to ESG risks

There is an implicit social contract between the insurance sector and its customers, with the latter dependent on insurance companies for sharing the burden when unexpected events occur. The Covid-19 crisis has only served to reinforce this contract, emphasising insurers' societal responsibility and that of the companies in which they invest. 

It has demonstrated how vital sustainability considerations are to the insurance sector and should accelerate the transition from being shareholder-focused to encompassing a broader range of stakeholders. It should also help insurers adapt to other ESG risks that can cause widespread disruption to business activity and communities. 

The industry is already on the front line when it comes to environmental concerns. It is responsible for underwriting natural disasters, which are growing in magnitude, frequency and unpredictability amid man-made climate change. There could come a day when these catastrophes become uninsurable for the private sector. 

Sustainability risks in relation to future claims have been under the spotlight for a while. But we have chosen to focus this study on the less covered - but equally critical - sustainability risks that relate to the asset side of the insurance business, where insurance companies park capital until it is needed for paying out claims. 

If insurers do not carefully supervise their portfolios, they could be taking risks that compromise their ability to meet liabilities, potentially risking insolvency. Stringent regulatory restrictions on the types of assets insurers can invest in make their portfolio management decisions even more essential, and choices around sustainability are a core ingredient of that task. 

Risk managing the risk managers: Assessing investment, underwriting and regulatory risk

To carry out our research into sustainability risks for insurers’ portfolios, we spent four months engaging with 11 companies. These included re-insurers, diversified insurers and life assurance providers. Some of them were household names and others were niche operators, ranging from small to large market capitalisations. 

We spoke to numerous executives and had countless internal debates to evaluate how the industry is integrating sustainability factors into its asset allocation process. We looked at a variety of factors including sustainable investment strategy, team structure, executive responsibility, remuneration linked to sustainability outcomes, voting and engagement policies, reporting and participation in external standards. 

Sustainability has a direct impact on future proofing an insurance company’s balance sheet against a variety of potentially existential events, including regulatory crackdowns, underwriting challenges and investment risks. Regulation is already acting as a push factor driving sustainability up the agenda for insurance companies. With the first ever ESG guide specifically targeted towards the global insurance industry published by the UN Environmental Programme (UNEP) in December 2019, adopting a long-term approach to climate-related risk is an urgent priority.

Underwriting and investment require insurers to properly assess the costs of events and the outcome of investments, to ensure cash flows match pay-outs in both timing and size. Sustainability factors introduce an extra complication that requires experienced practitioners to be fully aware of and manage risks as they evolve.

Key findings

Attitude to sustainability is key

Market cap and the level of sustainability do not correlate strongly in this study. It is reasonable to expect that a company with greater resources is able to invest more in hiring talent and developing systems and processes for collecting, analysing and monitoring data. But we found that if the will was there, insurers could develop a forward-thinking ESG strategy, irrespective of size. 

The companies with the most commitment to sustainability were also the most ambitious. One company employs 40 responsible investing officers with 20 per cent of their compensation explicitly linked to ESG outcomes. Other insurers have shown a remarkable level of consideration for the effects of Covid-19 on customers. For example, some motor insurers have offered refunds to customers to offset less driving through the crisis, although these companies were not obliged to do so. 

Scenario analysis is proving to be an effective tool for many insurers. Mapping the pathway of different increases in world temperature is a commonly used technique to help frame the risks of global warming. One insurer commissioned a team of economists to develop a value-at-risk (VaR) measure of their portfolio to climate change. 

We found that companies that embrace sustainability challenges are more likely to share knowledge and collaborate on projects with rivals because they recognise that players across the sector face common hurdles and combining expertise is mutually beneficial. Some companies even invited us to join working groups designed to deal with sustainability risks.

No standardised sustainability approach

Companies use a variety of approaches to integrate ESG, from exclusion lists to best-in-class selection, from norms-based to thematic investing. In some companies, responsibility for sustainability sits with the chief investment officer (CIO), while for others it is outsourced to third parties. Some insurers are actively engaging with investee companies in their portfolios while others have set up dedicated impact funds.

This shows is that there is no universally agreed approach to sustainability in the insurance industry and different measures suit different companies. The important thing is for insurers to be consistent with their wider function in society. For example, one healthcare insurer decided to exclude tobacco investments from its portfolio to better align with its fundamental corporate purpose. 

As investors, we have to adapt to this non-standardised range of approaches and critically evaluate each sustainability solution in the context of the specific business model and social function. There should be distinct ESG approaches across asset classes because the challenges are not always the same. 

The ‘S’ needs work on both the investment and underwriting sides

We found insurers generally had a high level of sophistication around environmental issues, particularly catastrophe-exposed companies. But the social aspect tended to receive less attention. The effects of Covid-19 sit squarely in the social box, and the outbreak is a timely reminder that insurers cannot neglect this aspect. 

The crisis has brought attention to insurance policy wording that is often ambiguous about how business interruption and losses related to event cancellations are dealt with. Some underwriters have been quick to clarify the coverage of policies, often to limit future exposure. But customers now have more awareness of the devastation a virus can cause, and a longer-term consequence of Covid-19 may be that more resources are directed towards dealing with pandemics.

In the US, the emerging opioid crisis could unleash a wave of claims on certain healthcare companies. Insurance companies should be factoring this into their portfolio management (as well as underwriting). For us as analysts, we need to pay particular attention to the social risks contained in insurance company investment portfolios, as well as their liabilities.

Leaders, followers and laggards

Different sub-sectors of the insurance industry have varying levels of sustainability exposure related to investment and underwriting risk. For example, life insurance companies are highly exposed to investment risk because of the need to purchase long duration assets to match the long-term nature of their liabilities, so integrating sustainability factors on the asset side is crucial for these insurers. 

Re-insurers have high exposure to underwriting risk because they often insure major claims related to unpredictable events and therefore a well-developed sustainability framework for underwriting is particularly useful for these firms. While bearing these factors in mind, it is possible to map the materiality of different risks to different sub-sectors and compare a company’s level of sustainability to that of its peers.

Overall, we were pleasantly surprised to find that most insurance companies are treating sustainability with considerable seriousness, but the key factor is the pace of development. We separated the companies into three categories: leaders, followers and laggards. 

The leaders we identified were creative and industrious in their approach, and discussions with them took a tone of knowledge sharing, partnership and learning opportunities for both parties. We have taken these learnings and incorporated them into our criteria for assessing ESG ratings. We also shared our sustainable ratings methodology to help them understand materiality from the investors’ point of view. 

The followers are on track with developing ESG integration and have clear next steps. The laggards have much further to go. Some of these companies were particularly disappointing given the considerable resources at their disposal; this was usually because of low engagement with sustainability. Other laggards demonstrated a genuine willingness to work with us on an ongoing basis to better integrate ESG into their business models.

Key areas of sustainability to watch for insurers

We expect the insurance industry as a whole to make significant progress on sustainability in the coming months and years. Key areas to watch in order to assess the speed and ambition of this progress are:

• Responsibilities: Increase in top-down commitment to implement sustainable investing policies, and ideally ESG committees at board level.
• Resources: More personnel in standalone ESG teams, but also empowered sustainability champions across different business units.
• Products: An increase in green bond and social bond issuance - insurers tend to prefer capital raising in the fixed income markets. A general rise in investment in ESG focused/labelled products, either developed in-house or from third-party managers.
• Disclosure: Greater transparency around voting and engagement actions in investments, and more detailed disclosure on specific asset classes.
• Policy: Policies are currently mainly exclusion-based around coal and other oil and gas activities. Those companies not yet signed up to the UN PRI (Principles of Responsible Investment) will face pressure to become members. We also expect more formalised approaches across different asset classes to signal awareness that ESG considerations should be tailored to specific markets.

We intend to launch a second round of engagements, checking to see how companies have progressed compared to their targets. We also plan to broaden the scope of this research project following emerging sustainability issues hastened by Covid-19. These include risks to infrastructure for running businesses remotely, digital customer offerings, cyber security, employee welfare, customer and supplier engagement and understanding how the pandemic will inform executive remuneration.

Applying the findings to stock picking

By analysing how an insurance company manages sustainability, we can develop a greater understanding of how it manages risk as whole. As a result of the project, we changed the sustainability rating of some companies and evolved the criteria we use to assess ratings across the sector. 

For example, we are placing greater emphasis on who or what is responsible for driving the sustainability policy at an insurance company. We found this to be a significant differentiator for ESG integration. How the company articulates its role as a long-term steward of capital makes a difference to sustainability outcomes. Where there is little interest in managing sustainability risks, we expect this to have longer-term implications for a company’s ability to attract investor capital. 

In terms of an insurer’s portfolio management, we seek to understand where sustainability enters the investment process and whether it is seen as a risk mitigator or alpha generator. The level of engagement an insurer applies to its investee companies is another good barometer of ESG sophistication. That said, stock selection is a complex process, and sustainability is one part of an intricate puzzle. 

The right strategy treats sustainability as a dynamic area, enriched by continual enhancement. That is why we are incorporating the findings of this project into our own sustainability ratings and launching another round of engagement. What we learn informs those companies we engage with and vice versa, working together to manage sustainability risks around claim liabilities and to the asset side of the business on behalf of their clients and ours.