Institutional investors backing ILS call for climate action

The world’s largest institutional investors are increasingly vocal about the need to accelerate efforts to tackle the climate crisis, with many of the same group also contributing a significant proportion of the insurance-linked securities (ILS) market’s capital base.

Last week, 631 institutional investors which between them are responsible for managing more than $37 trillion in assets joined together to call on governments to increase efforts to tackle the global climate crisis and achieve the goals of the Paris Agreement.

The group of investors published a joint statement at the United Nations Climate Conference (COP25) last week, calling on governments to phase out thermal coal power, put a meaningful price on carbon pollution, stop subsidising fossil fuels and ​work to meet the goals of the Paris Agreement.

“We are concerned that the implementation of the Paris Agreement is currently falling short of the agreed goal of “holding the increase in the global average temperature to well below 2°C above pre- industrial levels and to pursue efforts to limit the temperature increase to 1.5°C above pre-industrial levels,”” the investor group wrote to world leaders.

The group also said that investors are “increasingly incorporating climate change scenarios and climate risk management strategies into their investment processes,” which given who features in this group of 631 investors should provide those managing insurance and reinsurance linked investment strategies a little pause for thought.

Within the group are some of the largest pension funds, sovereign wealth funds, superannuation funds and endowments and looking down the list, which is available at the foot of their joint letter, there are a significant number of large ILS sector investors involved.

Just picking out up to twenty names from this list of 631 can get you to around $20 billion of allocations to the ILS asset class, which right now is more than one-fifth of the entire market.

It’s almost certain that if we knew the allocations of the other investors listed here, this group of major institutional asset owners could account for more than half of the ILS industry.

As investors become increasingly aware and in some cases activist on climate related issues, there is both an opportunity and a risk for the ILS and traditional reinsurance market.

ILS and reinsurance can mobilise this capital and put it to work in protecting both the most economically developed and the most vulnerable regions of the world against the impacts of climate related risk and catastrophes.

That is a significant opportunity as these major investors are looking for “climate positive” and socially responsible investments, features of an asset class that the insurance-linked securities (ILS) market has in abundance.

But to mobilise this capital meaningfully, the ILS market is also going to have to demonstrate that it is a good custodian of their money, which means giving these investors the confidence that the risks are understood and most importantly priced for.

We discussed this last week, when we explained that capital may be required to help the P&C insurance and reinsurance industry in its response to climate change and rising climate related risks.

But to mobilise the necessary capital, it’s going to be increasingly important to give it the confidence that the risks it is backing are understood.

As we explained in that article on the insurance and reinsurance sector:

If the industry hasn’t sent the right signals on price and demonstrated its efforts to cover its loss costs, then the capital providers (including major ILS investors) might be more hesitant to back a sector which, in some quarters at least, is seen as failing to price in the full and growing risks of its climate exposure.

There are obviously significant opportunities in ILS to provide the large sums of financial risk transfer protection to help the world in its adaptation to face growing climate related risks.

Giving investors confidence that climate exposure is well-understood, being dealt with effectively and most importantly priced for, is only going to become more important down the line.

As institutional investors become increasingly focused on deploying their capital where they know it is climate neutral, or supporting climate adaptation and risk management, the insurance-linked securities (ILS) and reinsurance sector is one of the few opportunities where they can see real data and analysis driving decisions related to climate risk.

It’s going to become increasingly important for ILS and reinsurance players to be able to demonstrate how they take decisions related to climate exposures, why their decisions can be trusted and relied upon and so give the investors the confidence they will be looking for.

As environmental, social and governance (ESG) related factors drive ever larger amounts of institutional capital into asset classes deemed as appropriate, the ILS market has an opportunity to be one of the largest beneficiaries.

But the effort to explain how climate related risks are analysed, understood (as well as they can be), underwritten for, and most importantly priced into the contracts underwritten, is going to become key.

The ILS market needs to upskill in this area, to be able to tell the right story and demonstrate to investors allocating to it, that they can have confidence that climate exposure is being accounted for, as best as can be achieved using the latest data and analytics technology.

That’s also important to remember.

There remains an element of ‘unknowability’ with climate risk. So ILS market participants have to be able to give capital providers the confidence it is managing climate risks to the best of its ability, pricing for it as accurately as possible, and, if or when projections prove wrong, adjusting its benchmarks to ensure future capital allocation decisions are reflective of what has been learned.

Our upcoming conference ILS NYC 2020, held in New York on February 7th, will feature a session focused on climate, resilience, and socially responsible risk transfer. Register soon to attend.