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Date: 08/07/2020

Title: The Charm and Challenge of Sustainable Investing for the ILS Market

Teaser: Sustainable investing has gained a lot of traction in the financial world recently. What does this mean specifically for the ILS market, and how can an ILS investment be made in line with ESG considerations?

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The Charm and Challenge of Sustainable Investing for the ILS Market

«We all know that as we are beneficent towards Nature, it becomes beneficent toward us» – Xenophon. Already the ancient Greeks realized the importance of sustainability and the E in ESG[1]. Sustainable investing has gained a lot of traction in the financial world recently. What does this mean specifically for the ILS market, and how can an ILS investment be made in line with ESG considerations?

Authors: Patrick Roder, Markus Ott, Matthew Kirke

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Sustainable investing (SI) is defined as integrating non-financial factors, such as ESG criteria, into the investment process based on ethical values.[2] According to the Global Sustainable Investing Alliance, between 2014 and 2018, the global volume of sustainable investments grew by 40% to USD 30.7 trillion. Nearly half of this is managed in Europe, where sustainable investments grew by 20% between 2014 and 2018 despite increasingly strict standards and definitions for sustainable investing.[3] Contributing to this growing trend are both market forces and internal drivers. Regulatory development, reputational risk, competition, and a larger investor universe are possible external drivers of efforts to integrate ESG into the investment process. Internal drivers range from altruism to risk management and the attractive cost of capital.

ILS is unique in that it introduces investment opportunities in which the underlying assets have inherent ESG qualities. The disaster relief capital provided by the ILS industry increases resilience and amounts to direct and indirect support for multiple UN Sustainable Development Goals. It’s not surprising that ILS players are interested in understanding how to incorporate SI as part of their value proposition.

ILS players that want to build SI capabilities should do it holistically to achieve their desired business outcome. We suggest an SI framework consisting of four components:

  1. First you create a foundation for the SI framework in the form of an SI strategy on the basis of which you determine the relevant culture, principles, governance, and compliance rules.
  2. This foundation allows you to define ESG products and assess the operational ESG footprint.
  3. On this basis, you then have to define ESG data integration and analysis, technology management, and the target operating model.
  4. Finally, you should define reporting capabilities, align internal and external communications, and train all the relevant personnel.
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Here we’d like to focus on a key step within the SI framework: defining and launching an ESG product. To incorporate ESG into the investment process of an ILS fund requires due diligence along the whole risk transfer chain. This means that policy holders, intermediate risk transfer entities, service providers, collateral investments, fund structures, fund managers, and the use of freed-up capital should be analyzed to see how they align with ESG criteria.

We currently see four ways for an ILS fund to make sure an investment fulfils recognized ESG criteria (the extent to which they are adopted depends on the fund’s own SI strategy and the ILS instrument): 

  1. The ILS investment receives a third-party accreditation, for instance the upcoming EU Green Bond Standard.
  2. The cedant or sponsor uses an existing or proprietary ESG approach without external verification.
  3. Contractual language excludes certain risks from being ceded or defines the use of ILS proceeds.
  4. Sponsors, cedants, or other sources, such as brokers or third-party data providers, create transparency on the ESG characteristics of underlying risks and operations of the cedants through the disclosure of relevant information. 

While the latter two ways describe current practice, the former two are yet to mature.

Whatever the motivation for introducing an SI strategy, its implementation should always follow a structured approach to drive a sustainable future for business.

Contact

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Patrick Roder

[1] Environmental: impact on climate change, natural resources, pollution & waste management.
Social: human capital, social integration, and labour relations.
Governance: concerns management structures, renumeration of staff, and tax compliance.
[2] Kwon, T. & Paetzold, F. (2019): Sustainable Investing Capabilities of Private Banks—Report #3: Assessment of 20 European Private Banks, p.6.
[3] Global Sustainable Investment Alliance (GSIA) (2017): 2016 Global Sustainable Investment Review, p. 7; GSIA (2019): 2018 Global Sustainable Investment Review, p. 8f.

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