As ESG transparency factors into renewals, what does that mean for ILS?

Broking powerhouse Aon has highlighted that environmental, social and governance (ESG) transparency is increasingly a factor in commercial and business insurance renewals, which suggests this will eventually cascade to reinsurance and retrocession renewals as well.

Commenting specifically on insurance renewals, Aon explains that ESG transparency is increasingly demanded of protection buyers, as major insurers become more focused on paring down their exposure to industries and businesses deemed not to meet ESG standards.

Environmental, social and governance (ESG) discussion is often focused on the investment side of the insurance and reinsurance industry, also in insurance-linked securities (ILS).

Investor-demand for ESG appropriate assets and investments is growing rapidly and Aon notes that a Bloomberg forecast suggested that ESG based assets could exceed US $53 trillion by 2025, representing more than a third of total assets under management.

That’s an enormous figure and right now it’s hard to see how $53 trillion of truly ESG appropriate assets can exist by then, without significant change in industries and economies around the world.

The push to combat climate risk and to invest responsibly to support climate mitigation and adaptation is driving some of this investor appetite, but so too are investor ambitions to “do no harm” in their investment strategies, a mantra for some of the largest ESG allocators around the world.

Investments can drive change more deeply into business strategies, as industries could find capital will dry up unless they become more ESG focused.

For our industry, Aon explains, “the ability to access the insurance markets is also increasingly reliant on ESG performance.”

The insurance market is moving towards increasing alignment with positive ESG outcomes, which is already making it harder to secure cover in some industries like oil and gas, as well as other carbon intensive areas of the economy.

But Aon rightly notes that ESG runs much deeper, into the supply-chain and to customers, where negative ESG traits are likely to weigh on the perceived ESG-readiness or appropriateness of an organisation, which could also factor into their ability to secure the insurance they want, at the price they would like to pay.

Industry capacity is beginning to shrink for certain sectors as a result of this, making ESG transparency and data a necessary feature of renewals, as carriers demand more insight into how their customers operate.

Aon explains, “The hardening market has put more emphasis on clear information disclosure and ESG adds to the number of data points to be collected.

“Having clear ESG related targets, measurable metrics and a purpose and timeline for future performance is critical, but there is also a lot of insurer focus on the transition risk as organisations move towards a carbon neutral future. Being able to show a plan for improvement will help facilitate continued partnership with carriers and, as with cyber risk, it’s important to build time to consider ESG into renewal schedules.”

Aon spells out the issue facing some protection buyers, “Companies need to do their bit to showcase their burgeoning ESG credentials to secure both future investment in their businesses as well as competitive risk transfer options on their traditional risks.”

This is likely to cascade to the reinsurance market as well, where ESG transparency is expected to become a priority at renewals time as well.

That reads across to the insurance-linked securities (ILS) market, of course, particularly as the ILS industry increasingly pushed to make investment options that align with investors ESG allocation priorities.

But let’s think about how that cascades and how this could become challenging, or even a burden, for those carriers and reinsurers looking to access capacity, as ESG priorities increase across the industry.

Gaining comfort in a single organisation or businesses ESG readiness is one thing, already this is becoming an additional renewal task for insurance carriers.

But for a reinsurance company, a retrocessionaire, an ILS fund, or even catastrophe bond investors, the transparency, data and disclosure required to gain comfort and confidence in a portfolios ESG appropriateness could be a much bigger task. While standards don’t currently exist for this kind of data, plus every organisation’s risk within a portfolio will differ, the scale of this challenge becomes clearer.

Notably, most pronouncements from major re/insurers on their desire to make the underwriting side of their businesses more ESG appropriate are focused on the primary side.

Perhaps starting here is the right approach, as if all primary business risks underwritten came with clear ESG disclosures, data and transparency, then reinsurance deals wrapping these risks up at different levels in the market would inherit the certainty taken from the primary underwriters assessment of ESG.

But is that likely to happen fast enough? Or will reinsurers, retrocessionaires and ILS funds be demanding greater ESG transparency before all the primary clients are aligned?

It seems likely that will be the case, especially when it comes to an instrument like a cat bond, where one side of the market equation is strongly driven by investor appetite.

It’s clear that ESG is going to become a reinsurance renewal factor, which means it will too for retro and ILS transactions.

But ILS could become the fastest driver for this perhaps, as investors drive that market to a degree.

Which throws up more interesting questions.

Such as, could we reach a stage where sourcing sufficient ESG appropriate risk becomes a little challenging?

On the flip side of this issue, could ESG appropriate portfolios of risk achieve better execution, when it comes to reinsurance and retro, especially where ILS investors and the capital markets are involved?

The execution of a recent ESG catastrophe bond sponsored by Generali may have provided a hint of how this could go, as it priced with perhaps one of the lowest multiples-at-market of a cat bond ever.

It’s important to note that it is still early days for ESG on the underwriting side of the insurance and reinsurance market, which means while ESG will increasingly factor into renewals, it may not become core to the ability to secure reinsurance and retro capacity for some time yet.

But there’s a lot riding on successful ESG adoption for insurers, reinsurers and indeed the ILS market, which means it is likely to become an increasing focus and a priority for assessing the quality of risks and portfolios of them.

Aon also rightly notes that there is yet another side to the ESG issue in re/insurance and risk transfer, that protection buyers are increasingly going to seek out ESG risk transfer products as well.

So as well as having to be transparent on their own ESG credibility, organisations are going to “be expecting the insurance industry to innovate to help them transfer new risks emerging from ESG factors,” Aon explained.

In order to satisfy the evident investor demand for ESG quality assets, filling some of the ESG-related protection gaps, such as for climate risk protection, may become a viable route for innovative ILS managers.

ESG investing is a growing focus for the insurance-linked securities (ILS) market. Read more of our insights on this topic here.