Aileen Mathieson, Global Head of Insurance as Aberdeen Standard Investments (ASI), talks ESG inclusion, investment management and asset allocation as she explains further the findings of Aberdeen Standards Investment’s recent ESG Insurance survey into what drives ESG in Insurance.

With risk management still being the main driver in ESG practices, why do businesses not yet see ESG as a driver for business or investment opportunities in its own right?

The insurance business exists to manage risks, so it is not very surprising that risk management is a primary driver and it appeals to all insurers regardless of their appetite for ESG. So, from our perspective we believe Insurers see risk management as universal. Most of the focus to date has been to avoid potential unsustainable business models, stranded assets and regulations such as PRA and climate stress testing focus are assessing the impact of particular transitions on the investment portfolio and that plays naturally to a focus on risk management from that perspective.

However, we also see that insurers are regarding ESG across businesses from a holistic perspective, in terms of looking at it from their corporate commitments to Net Zero and how this plays through all areas of their business, such as such as, for example, underwriting, and the products offered to their customers. Whilst investment management strategies are important in their own right, they also have to link with the overall business strategy and ESG commitments. Consequently, we see that the plans for ESG integration into investment management are also closely linked with corporate objectives and proposition development.

A final point to make is that we have seen insurers increasingly sign up to Net Zero commitments. In addition, particularly towards the end of last year, there were quite a number of insurers signing up to the UN Net Zero Alliance commitments. Consequently, we expect this to drive more ESG related investment activity and proposition development.

Post Covid, we have seen a lot of insurers talk much more publicly about ‘building back better’. I know there is much focus in the UK (also Boris Johnson’s ‘Building Britain Back Better’ initiatives), but we see this as a theme in a number of markets in Europe. Insurers have an important role to play because, for some, the long-term nature of their investment strategies fit well with the nature of the type of investments required to support the post Covid recovery.

Can you explain further how regards to ESG vary significantly between long-term and short-term investments?

The Paris goals have traditionally been articulated more in the longer term focussing on Net Zero by 2050. For the P&C insurers in particular with shorter duration portfolios these longer-term goals might not have seemed relevant to the P&C insurers. There is also less direct visibility of the underlying investment strategy to the end customers in P&C which means that the external stakeholder pressure has perhaps not been so prevalent in P&C as in the life and pensions sector.

However, we expect that to change for the P&C insurers, particularly with the increased focus on exclusions and transition assets.

How has the increase demand from the customer base driven insurers to create a competitive edge with sustainable products?

The impact of this depends on the nature of the insurer’s business, particularly with insurers who have exposure to pension schemes and pension scheme assets, as they have had to consider these aspects earlier than the P&C Insurers as they have had regulatory pressure, regulatory change and more visibility in terms of products and solutions investments.

In terms of the pension schemes in particular, there has been much more progress made in the UK DC space recently where we have seen much more ESG focus, particularly with regard to climate related investments, in the defaults being launched over the last 12 months. For P&C Insurers we expect that the pressure will increase, but that pressure is coming more in the short term from corporate stakeholders and Regulators rather than customers.

However, we will continue to see ESG considerations become more prevalent in underwriting processes as well. For example, there is increased scrutiny on the P&C insurers regarding the type of risks and business lines they underwrite. The ability to move forward with ESG innovation is also somewhat impacted by the Insurers’ Strategic Asset Allocations, and also regulatory treatment of these asset classes, particularly Solvency II capital treatment, and the ability to include these assets within unit-linked solutions.

With regard to asset allocation, traditionally Insurer asset allocations didn’t have material allocations to these asset classes. However, with insurers broadening out their asset allocations and including more illiquid asset classes, which can support more longer-term sustainability and climate solutions, we see the ability to include increased ESG content in new solutions starting to change.

At ASI we have developed an innovative approach to the inclusion of forward-looking climate risks into our strategic asset allocation capabilities and we are seeing much interest in this. With regard to unit linked innovation, the revision of the UK permitted link rules in 2020 now enables Insurers to bring more innovative PE and illiquid asset classes to retail policyholders. Earlier this year we launched the first Venture Capital fund, a solution fund for policyholders in partnership with Phoenix and this does have an ESG focus.

Looking towards the future, how will insurance investors continue to respond to the mounting ESG challenges facing the industry?

I think there are two areas for this:

• A question of stewardship vs divestment:One of the biggest challenges for the Insurer, is the need to consider how to incorporate ESG stewardship and where to apply divestment or active engagement. Given the nature of the different stakeholders and clients, likely most Insurers will have to do both. Currently, we see much consideration being given to the development of policies, investment strategies and practices within Insurers to address this topic and the subsequent impact on the investible universe of these policies. There are also considerations regarding how Insurers want to use their asset owner status through stewardship. We see much interest and receive many questions coming from insurance clients on our corporate engagement practices; what we vote on, when do we vote, when do we abstain and so on. We have also observed a step up from insurers wanting to have an active role and be able to use their weight as part of stewardship to be able to influence companies, possibly more so than they did in the past. I think this is the challenge for insurers to possibly think about, particularly if you are an insurer with a large balance sheet of your own, but also policy holder products, how do you get the balance right between the stewardship and divestment?
• More focus on impact investment particularly post COVID:We also see some insurers who want to be a lot more pioneering in terms of investment strategies. It is not that investment returns don’t matter, but actually wanting to make impact investing as the primary driver of the investment strategy and measuring the outcomes of that, separate to the risk and return they get from it. I believe we will start to see more of the insurers’ balance sheets over time starting to be allocated in that way. This is definitely a theme we are seeing coming through.

What do you feel were the most surprising or impactful findings in the report?

There has been such a significant focus in ESG and the visibility of it, but three quarters of respondents still see it as a secondary driver to investment decisions despite many Insurers making public commitments to Net Zero targets.

We have also picked up in the report that 60% describe ESG as ‘rarely’, or ‘never’, influencing investment decisions. We see the practical challenges in the ability to incorporate ESG aspects into asset allocation modelling, product design and client reporting together with the regulatory treatment of more illiquid asset classes as the key areas that need to be addressed to improve this result. One of the things we believe will support this changing is having a global or European taxonomy. This will certainly make a difference to the ability of investors to access data in a much more efficient and timely way and improve the transparency and comparability of climate measurers in particular. There are a number of EU initiatives in progress here which should address these issues.

There is also, the aspect of technology within insurance companies and the amount of investment required, particularly in terms of policy holder systems, to support improved customer reporting on ESG aspects of investment solutions.

This is what we were surprised at when we understand some of the barriers that the insurers face, but there are some positive developments on the horizon. In the short term, particularly around the regulation and the data provision and ease of access to data, which we hope will help accelerate an improvement in the profile of ESG, to be more of a primary driver.

Aileen Mathieson is Global Head of Insurance as Aberdeen Standard Investments (ASI)