The environmental, social and governance investing movement was, for years, akin to a juggernaut relentlessly ploughing its way through all sub-categories of the asset and investment management industry. But in recent years, the media frenzy around ESG has cooled and the movement has even received some level of backlash in some quarters. Greg Winterton spoke to Johan Jonson, Risk Manager at Ress Capital, Dan Knipe, Chief Investment Officer at Kilter Finance and Sarah Nappi, Associate at NorthPeak Advisory to get their views on the current state of the relationship between ESG and the longevity/mortality markets.
GW: Life insurance companies, the main counterparty in the life settlement and life ILS markets, arguably support an ESG mandate well; they provide a societal benefit, they have a lower carbon footprint, and an exceptionally strong governance profile, especially in Europe and the UK. Do end investors understand this? To what extent do they drill down on counterparties for due diligence?
SN: Investor sophistication in ESG awareness and understanding varies widely. While many investors include ESG considerations in their due diligence questionnaires (DDQs) to some degree, a common issue is a narrow focus on high-profile topics, like climate change, that dominate public discourse.
At the more sophisticated end, some investors grasp the broader social benefits of ESG integration in areas like life insurance. These investors tend to prioritise rigorous due diligence on counterparties, which necessitates visibility and access to these entities. However, there remains an education gap for investors with a less advanced approach to ESG. This often results in a standardised approach to ESG questions, centred around well-known issues such as climate change, rather than tailoring inquiries to align with specific investment strategies and objectives.
JJ: We find that investors are often positively surprised when we present our ESG framework – we definitely see a variety of knowledge. The DDQs can be fragmented, and they vary significantly in terms of how deep they drill down. But most of the time investors are not considering the positive aspects of insurance companies. Those that do focus more on the governance side of things and not the environmental side of things.
That said, the investor landscape is changing quite a bit. Previously we saw them looking at ESG as a silo exercise, with the ESG committee sitting in different part of the organisation. But in newer wealth managers for example, it’s much more fully integrated. They want to understand fully what you’re doing and how you’re integrating ESG because the clients they manage want to better understand how their money is being used and whether it aligns with their core values.
DK: I think they do. In our experience investors appreciate the underlying foundation of strong governance in the insurance sector. They know that there are multiple layers of governance embedded within the sector – there is strong regulatory oversight, there are rating agencies involved, senior managers are subject to fitness and probity requirements, boards of directors need to have the high levels of appropriate experience, and within the businesses there is a firm separation of roles between risk management and front-office origination and underwriting. I’d agree that investors are less clear on the E and the S legs of the ESG stool as they apply to insurance, although we spend a lot of time talking to investors about the social benefits of insurance, of which there are many, and they get that quite quickly. It can be more difficult to well articulate how insurers, in general, are addressing the E leg, however.
GW: There is an oft-discussed trade-off in ESG in that a capital allocator must accept some kind of discount on returns if they want ESG-related benefits. That is not true in life settlement and life ILS – the ESG is intrinsically baked in. Do they understand this is not a zero-sum game in the life markets?
JJ: To some extent. We certainly don’t see a negative trade off – for us, ESG just adds value to the way we think about risk and how we run our strategy. But within life settlements I do think there is a slightly different focus – ESG is not the top focus. It’s important, but in the sourcing of transactions and purchasing of policies, there are other risks that we look at which, if well managed, will help us to deliver good returns.
DK: There’s probably not as much awareness of the fact ESG is inherently a core part of insurance investing. I think that as an industry we have to do more to message that the S and G aspect of ESG are baked in to an investment in insurance. We need to help investors realise that the value of the S and of the G within our industry can be as high as the more measurable E impact in others. When you look at the unit economics of insurance, the underlying product provides a social good – it helps people lead better, less volatile lives by smoothing the financial journey. By mutualising financial risks that individual policyholders face but are unable to bear alone it provides for a society where health, safety and peace of mind can lead to stronger and more equal communities. We probably don’t do enough to stress to investors that this social good is the reason that insurance exists in the first place.
SN: This is still something we’re hearing but it’s about communicating what it means – it’s about the value add, and not the trade-off. It’s about directly communicating where the strengths of a particular investment are as it relates to ESG, and it’s not about being everything to everyone. Managers need to create value in their own category, and manage ESG risk in a better way, and help investors to understand that.
GW: If an investor is choosing between a life risk-type fund delivering 12% returns and, say, a direct lender delivering 16%, when would they select the life risk fund? How are they screening and how can life risk managers make their case in this situation?
DK: Most investors will be trying to maximise returns, investing in well governed companies, while doing societal good and reducing environmental harm. However, it’s more nuanced than your example. For a lot of investors, some level of compliance with their ESG policy is necessary to make an investment but it’s definitely not sufficient. They’re going to be looking at the volatility of both products and the underlying risk exposures. If one of the options is a better diversifier, then many investors could accept a lower return for that, for example. They’re thinking about how they can make the returns in the most socially and environmentally friendly way they can. While many investors would not invest with a manager if they don’t take ESG seriously, they wouldn’t necessarily invest with one just because they are.
SN: It is the lack of quantitative data that hinders the S and the G. On the environmental side, greenhouse gas emissions is just one example of something that an investor can hone in on. If you can’t quantify it then you have to transparently communicate a narrative about the value add of the investment. But that’s definitely more difficult because numbers are a compelling part of the narrative. It’s about trying to find ways of articulating the positive impact without the data to support that.
JJ: It’s a challenge. We have a specific case where we have avoided governance-related risks – we focus on governance and credit risk as part of our due diligence process so yes, this is an example of where something ESG-related has paid off in terms of limiting the downside risk here. It’s difficult to quantify it but it’s still a case study where something happened, and we weren’t exposed to the subsequent risk. It’s becoming more of a hygiene factor for managers to have a sound ESG framework in place to avoid taking unwanted risk and to contribute to long term sustainable financial industry. Some investors are looking for the narrative of how ESG is adding value but that’s nothing we come across very often.
GW: Given that governance would seem to be the main leg of the ESG stool where the life markets can make their ESG pitch, what is the best way to do that? How much of the work rests on the trade associations in the space, versus the individual managers?
SN: It’s a question of transparency. Managers need to be thinking about transparency in terms of their communications with investors and in terms of their due diligence in their investment strategy and again, communicating that clearly. It needs to be made a standard part of the conversation, and I do think that it does come down to what are the individual managers, and their peers are doing and seen to be doing.
JJ: The governance side of things is also about not taking unwanted risks that we are not being compensated for – it’s not only the structure of the market and consumer protections. One doesn’t exclude the other and we need to be careful that we are not only pushing the governance conversation in one direction.
DK: If you separate ESG into the three separate categories, then the insurance industry, the private equity industry, ILS funds, lenders, board of directors, trade bodies, everyone should be making the case that there is a societal benefit from insurance and a strong governance framework. It’s not incumbent only one group or firm to drive this and as I said, we need to push the S as much as the G.
But what would really help is if the government would get involved. We already have an example of this in Florida, where there is a government backstop to provide home insurance for people who can’t get it in the market. I’m not saying this is the answer in other places, but in Florida, the insurance industry is talked about as having good governance. But in the UK and other states of the US and other countries, insurance doesn’t get any airtime, probably because it’s viewed as boring. If governments were to push the benefits of insurance, then I think that would have a big impact in terms of general investor awareness, and therefore, interest.
GW: Lastly – is there a silver bullet – or maybe more realistically, low hanging fruit – that life risk asset managers can take advantage of to better position themselves as an ally to the ESG movement? Or do these markets have too much of an awareness problem already that they need to tackle without the need to complicate things with the ESG conversation?
JJ: In life settlements, we need to continue to increase the level of awareness of the asset class and help get rid of the misconceptions that some investors have about the market. There is still a huge misconception that this is unethical despite there being a very positive outcome for the consumer. We’re not starting from level ground here – we need to ‘get out of the basement’ so to speak and onto the level ground before many investors can think about the positive ESG aspects of our asset class. That said, we are going in the right direction – there is more in the media now that is supporting this topic. It’s just a case of continuing to do it.
DK: It’s tough. You mention awareness – for me, it goes back to insurance as being boring. If you need to make a claim, you want them to be there, but normally, people don’t want to hear from them. Elevating this in people’s minds is too big of a task for the asset management industry to do on its own. I think it’s a case of each individual asset manager educating their investor base as to why insurance makes a good investment and excellent risk adjusted returns while meeting the necessary condition of being ESG compliant.
SN: I’m not sure there is. You have to understand where the ESG conversation is focused right now, which currently is on environmental factors. Climate change is the number one ESG-related issue for investors, followed by biodiversity. These subjects are easier for investors to wrap their brains around and they are more digestible. Social factors are so broad, but human rights and supply chains are the main consideration here. Life markets are navigating topics where investor focus often appears less directly relevant to life insurance products. Asset managers and other stakeholders in this space should therefore persist and expand their efforts to educate investors on the unique ESG considerations within life insurance.
Johan Jonson is Risk Manager at Ress Capital
Dan Knipe is Chief Investment Officer at Kilter Finance
Sarah Nappi is an Associate at NorthPeak Advisory