ESG a “major consideration” for ILS sponsors & investors: Gallagher Re

Environmental, social and governance (ESG) issues and the ESG appropriateness of investments, emerged as a “major consideration” for both insurance-linked securities (ILS) sponsors and investors during 2021, according to reinsurance broker Gallagher Re.

ESG has been a topic of discussion in the insurance-linked securities (ILS) market for a number of years, in fact we first wrote about catastrophe bonds and reinsurance-linked investments as being an asset class with social importance beginning in 2014.

But in recent years, the ESG focus among both investors and ILS investment managers has increased significantly, while sponsors too are also increasingly aware of and motivated by ESG related factors.

2021 is seen as a year when ESG in the insurance-linked securities (ILS) market became a “major consideration” for both the sponsor and investor base, with investors including investment managers here we assume, according to Gallagher Re’s capital markets and ILS focused unit.

However, it’s still a nascent idea in the market really, as very few investments in ILS can qualify as fully-ESG compliant, rather they tend to meet one or two characteristics of an ESG asset, but fail on the point of transparency on the underlying portfolio of insurance or reinsurance risk.

“Applying and adapting ESG frameworks to ILS may take time so its ultimate impact remains uncertain,” Gallagher Re explained.

This is absolutely true, as to-date there aren’t any ILS or catastrophe bond sponsors that have supplied a completely ESG appropriate risk portfolio to the market.

Even sovereign catastrophe bonds, that provide coverage to a government so it can deliver disaster relief financing after a major catastrophe strikes, are hard to truly qualify as ESG appropriate.

Until we see cat bonds that have specific and documented terms around the use of payout proceeds, even these, sovereign focused and the most socially responsible perhaps, of catastrophe bonds, wouldn’t meet a strict ESG investor or allocator mandate.

The much-discussed Red Cross volcanic risk cat bond possibly does meet a stricter definition of what ESG really means, given its payouts will be routed via established Red Cross disaster relief financing mechanisms.

This single, relatively small transaction, is perhaps the single ILS or cat bond that could stand up to the greatest levels of ESG scrutiny.

When you look into collateralised reinsurance structures its even harder to envision these becoming truly ESG appropriate anytime soon, given the challenges to look through portfolios and see where payouts might go.

ESG allocators have a mantra of seeking to “do no harm” through their investments, which means to really satisfy and unlock these major allocators the ILS asset class  (and insurance and reinsurance) has to deliver on transparency first.

But, positively, there is now enough focus and consideration of ESG factors in the insurance and reinsurance companies that tend to sponsor cat bonds, that it does seem the ILS asset class is now on a steady path towards increasing ESG quality over time.

How long it takes until ILS would satisfy the very large, and very strict, ESG allocators of the world that it really has ESG credentials is uncertain.

But, what is encouraging, is that efforts are continuing to push the ESG credentials of ILS further and to enhance the environmental, social and governance aspects of the asset class, which will mean an increasing number of investors find the asset class appealing, we believe.

ESG has the potential to unlock more risk capital for socially responsible financing, such as disaster relief and recovery, while also directing ILS managers, brokers and structurers to think up additional uses for cat bond or ILS structured funding to meet societal needs and protect against exposures such as climate risk.

All of which bodes well for driving further growth of the ILS industry and helping it to evolve, which will open up opportunities in the market for product design focused investment managers and structuring teams, to develop the new breed of ILS asset, that both protects its beneficiary and delivers on an increasing number of ESG criteria.

Gallagher Re’s capital markets team (previously the Willis Securities unit) are bullish about the prospects for ESG in the ILS market, saying that “Early signals suggest a net positive impact.”

Longer-term, the positivity of the impact of the ILS market embracing ESG could be really significant, as the world needs efficient insurance and reinsurance capital to support and buffer against numerous societal and environmental risks, which we hope, in time, the clever structuring teams in the ILS and reinsurance market will develop new product paradigms to deliver through.

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