Climate change tops insurers’ agenda

Stewart: Everybody's talking about ESG these days and this podcast is no different. What is different is our guest. Our guest is from Robeco. Robeco has been a leading asset manager in the field of sustainable investing long before it was popular, long before it was making headlines. Robeco works with insurance companies, creating customized solutions and with specific focus on sustainable solutions. So we are going to talk about that and we're going to talk about their recently published 2022 global climate survey. And here to go over it with us is Ed Collinge from Robeco. Ed, welcome. Thanks for being on.

Ed: Hi Stewart. It's great to be here today.

Stewart: Everybody's talking about this topic. Let's talk about some of the highlights out of your survey. 84% of investors say that climate change will be central or a significant factor in their investment policy over the next two years, and 75% say it's already the case. I'm going to go out on a limb with no data and say that was substantially different five years ago. What's going on with ESG investing and insurance companies today?

Ed: Yeah. So I think, I can actually give you the number from two years ago. So it was only 34%, two years ago.

Stewart: Is that right? Okay. That's a huge change.

Ed: That's a huge change when you think climate's gone from 34% to 75% today. And I think the really cool thing about our survey and everything about sustainable investing is, we've seen a real acceleration in the last two years in terms of insurance companies looking to embrace sustainability. I think, you mentioned Robeco, we were doing sustainable investing, as you said, before it was cool. So for us, it was always actually how'd you add additional return? How'd you get additional investment performance? So ESG data criteria give you more information, better informed investment decision, better outcome for our insurance clients. We always approached it from that and integrated ESG into everything we did back in 2010, but we've seen that structurally shift in the last few years, in particular—much more towards insurance companies and other investors wanting to make an impact, wanting to make a change through their investment strategy and climate, I think is the one area that has really resonated across all insurance companies globally.

You just have to look to COP26 in Glasgow recently, where over 90% now of the world's GDP is signed up to net zero, limiting the impacts of climate change. We see regulators looking at this, we see insurance companies looking at this, insurance companies are leading the way. And I suppose one of the questions you often got asked is, what's the impact of say COVID for example, being on insurance companies or the investment portfolios? And, I always thought perhaps sustainability would resonate less, or people would focus on it less, but, but actually we've seen a huge acceleration in pace and you highlight some great numbers there. 34%, two years ago, had climate within their investment policy, that's 75% today.
If you actually look at, and insurance companies are leading the way here, insurers globally from our survey, 59% have now signed up to net zero, or about to sign up to net zero. So, that's two thirds of insurance companies globally. If you actually look at those who are investigating it as well, there's basically 90% of insurance companies are on the verge or have already signed up to net zero, and therefore climate has become mainstream. And that is huge.

Stewart: We had Chris Fowle from PRI on and they have a real effort getting PRI signatories as well in insurance companies. I've often said that no industry has a better reason to use their balance sheet to help with climate change than insurance companies, because extreme weather impacts them directly in their claims figures. So it seems like it's a natural for them. Although I think the US has been substantially behind Europe and Asia in their adoption, which is why one of the reasons I think that Robeco has been a clear leader in this space for many years. One of the things that always seems to be the case, and whenever I hear people talking about ESG, it is somehow or the other, they feel like they're going to reduce their investment return, that somehow this is going to hamstring them or whatever. How do I work out being an ESG friendly investor and still maximize returns? And you just got done saying that you're using ESG investing as a way to outperform. So, can you talk a little bit more about that?

Ed: Absolutely. I suppose, looking at it from a climate lens. So if you look at our survey, that's 24 trillion of assets under management, that's clearly a big pool of assets. If you look to the Net-Zero Asset Owner Alliance, I think that's over 40 trillion of asset managers who've signed up to net zero as well. You've got the Net-Zero Insurance Alliances adding on another five trillion and so forth. And that's a huge amount of assets that are decarbonizing. And typically those are people, when they sign up to net zero, who are saying, they're going to reduce carbon in their portfolios by around 25% over the next five years. So suddenly you're talking about half of all assets are looking to decarbonize proactively over the next five, ten years.

And, actually that just moves market prices. So if you want a proof statement that ESG or sustainability can make a difference to returns, you just have to look at that because if you are not aware as an investor about the broader structural trends, the weight of money looking to decarbonize and the way it will actually change industries as well, because if you think of an oil company signing up to net zero, for example, that firm you invest in today is clearly going to be very different to the one that you'll be invested in 10, 20, 30 years time as they move to renewable technologies and the like.

So you kind of get a sense just from the economics of it, it has a positive impact in returns, or the potential for positive impact. And that's always the way we've looked at ESG as well, because if you think of what ESG are, companies that have sustainable business models, they have good governance, you would expect them to outperform in the medium to long term. And that's ultimately what ESG criteria are.

Stewart: So the survey also highlights that 56% say biodiversity will be central to, or a significant factor in their investment policy over the next two years. And I'm reading that carefully, because I want to get it right. Can you help define what is biodiversity?

Ed: Yeah, I think that was quite an interesting outcome from the survey actually, I suppose the question is what is biodiversity? And you're right. That's a very good question, because I don't think anyone has defined that yet. To actually make an impact, you have to define what you're trying to do. In my own mind, the way I almost look at biodiversity is: you can focus on climate and you can focus on getting to net zero, but that doesn't really help us if we've destroyed all the rainforests and the natural ecology on the planet. So actually biodiversity is a natural extension of the focus on climate. And actually when you look to the way insurance companies are looking at this and regulators, in France, for example, insurance companies have to have a policy on biodiversity. It only makes sense that as people are focused on climate, then biodiversity comes to the fore.

And one of the things actually in our survey that I think was quite interesting, I don't know to the extent you've looked at the UN sustainable development goals, but ultimately it's a framework of 17 goals, things like no poverty, climate action, and the like, looking to define what do you mean to do in terms of sustainability? You can frame it in an investment dialogue as well. And we also see that trend towards biodiversity and the answers we saw there. So, if you're looking to today, for example, 68% of people pick things like climate change or climate action, number 13 in the UN SDGs, if you look to biodiversity, or natural capital, I guess, which is life above land, life below the sea, that number's only 27%, but actually when you ask them, what are you going to be doing in two years time, that 27% on biodiversity jumps to 55%. So clearly that is the next theme that's coming on board after climate.

Stewart: That's a great insight. I was surprised by that too. I want to get into how insurance companies are doing this, but there's one last thing I want to ask about. So 22% of investors say that they will completely divest from oil and gas companies in the next two years. Now, a moment ago, you mentioned how there are some traditional energy companies who are changing their stripes, and making a net zero commitment. So is it as simple as I'm just going to blow out my oil and gas companies, or is it, I need to be careful. I need to be selective and thoughtful about who—all oil and gas companies are not created equally?

Ed: I think this is a very important issue you raise, because if you think about signing up to net zero or moving to a lower carbon world, there's two things you can do. You can make a proactive choice to change your investment portfolio. And I think that's perhaps what you're saying there, the 20% saying they'll exclude the energy sector in effect, or the majority of the energy sector, because clearly that will have a big reduction in CO2 in their portfolios, but that doesn't get rid of the problem because actually for us to get to net zero, you have to change the investment universe. So that's actually done through active engagement and ownership. And at the point you no longer invest in energy companies, you lose your voice, is the honest truth.

So the majority actually from my own dialogues and experience of insurance companies in particular, are really beginning to embrace actually, how do they actively engage on behalf of the assets they own. So rather than leaving it to their asset management partners, to do the active engagement and ownership, which they perhaps did historically, they're centralizing that process and having a central voice themselves in terms of how they engage with corporates or sectors to make that change. And you're right, we can't get rid of energy. People will always need energy. So actually we want to invest in the firms that are making that change, making the difference, reducing their CO2 footprint, investing in new technologies and hopefully being the carbon winners of tomorrow as a result of this structural change.

Stewart: What is driving the insurance agenda globally, and just more specifically insurance portfolio allocation themes in 2022 and beyond? What's the 50,000 foot view there from your seat?

Ed: So one of the great things about insurers, actually, it doesn't change much if you look at the general structural where insurance companies invest, what are the themes? If you'd ask me the same question five years ago, I'd have said, well, the low yield environment, insurance companies looking for more return, more yield, looking to invest in more private assets, looking to get liquid returns, or an illiquidity premium from their investments. And also looking to invest or, sorry, sell insurance products that are less capital intensive. I think we particularly saw this in Europe and more so in Asia now, but a huge structural shift to selling unit linked, or variable annuity business whereby the policy holder is taking the investment risk rather than the insurance company. And that hasn't changed in the last five years or so. What has changed is the ESG element that we're talking about today, and you talked a little bit about perhaps North America or the US being behind the rest of the world in terms of adopting ESG or sustainable investing.

And the way I look at the big change that happened in Europe was a few years ago where the EU basically forced insurance companies to have an ESG framework. So ESG investing, or ESG was always something that sits well with insurance companies, because if you think of what an insurance company does, it provides you downside protection in an unfortunate scenario. So, someone's stolen your car, a loved one's passed away, the insurance company steps in. So they always have a good social core to them, insurance companies, in the business they do and the people who work there. So ESG was always something that meant something to them, but it wasn't necessarily getting in the top two or three things that mattered for the insurance company to actually have time to focus on it. And then that regulatory push in Europe very much changed that. We've seen the same in Asia specific in certain countries.

And then you look to the US and if you rewind probably two, two and a half years ago, if I was visiting insurance companies in the US, we talk about ESG and the general response back was we're not really that bothered about it, but I think within ESG there are so many different things you can look at, and climate is clearly one of things. And that feels like the one thing that has really resonated with insurance companies in the US around ESG, and is bringing that to the forefront. We've seen regulators globally bring in proposed stress tests, consultation papers on everything to do with climate. And we're also seeing that in the US now with the AIC and also the New York regulator specifically looking at actually how much climate exposure are New York based insurance companies exposed to. And it's bringing it very much to the forefront of the agenda, which is hugely exciting, because for the first time ever, we have pretty much a global movement towards more sustainable investing from insurance companies.

So, it's a bit of a long winded answer to your question, but I think in you 2022, that's really what's resonating and is different to what's been going on for the previous five years.

Stewart: Don't worry, Ed, if anybody's familiar with being long-winded it's me. Look no further than my closest friends and family. Here's a question for you. So we have a CIO spotlight. So, we just had Leena Punjabi at F&G on. We've had a number of others. So if I'm Rip Reeves at AEGIS, if I'm Aaron Diefenthaler at RLI, if I'm Joe Eppers at Selective, if I'm Nick Martowski MagMutual, if I'm whoever, if I'm Eric Kirsh at Aflac and I decide I'm going to do this, I'm going to make a net zero commitment, or I'm going to become a PRI signatory, I think there's a perception that somehow or the other, you have to flip a switch and do it immediately. And insurance companies, as you point out, don't blow out of an asset class, or blow out of a huge position and buy back into something else. It tends to happen over time. So, how are CIOs and how are people incorporating climate into their portfolio today?

Ed: So the first thing is, I think taking that step to net zero is being honest, a leap of faith, because you're talking about timeframes over the next 28 years. And none of us know exactly what's going to happen over the next 28 years. So when people sign up to net zero, it is not flick a switch, everything changes overnight. It's more of a corporate philosophy, this is what we're going to do, and then we're going to enact change gradually over time. Insurance companies are clearly medium to long term investors. It's not a case of just suddenly changing the investment portfolio. It's looking about actually, how am I going to bring in say that 5% reduction in CO2 per annum in the portfolio. And part of that is really getting the data lined up. Actually, what is the current carbon position of the insurance company's portfolio? Where do they actually sit today?
Actually building that into insurance analytics and that's something we do a huge amount of really cool work around, actually—bringing in all those insurance constraints, cashflow matching, plus sustainability, whether it's impact investing or carbon, or actually building that into a portfolio. And one of the things that insurance companies can do is they can start beginning to exclude, for example, high CO2 emitters. But I think we've discussed, that's not necessarily the best outcome because you don't actively engage at that point.

Stewart: But that's low hanging fruit though, that's an obvious one. Your point, and I was going to ask you about this, your point about data and consistency of measurement, there's no, I can't tell the duration of the bond is 4.32. That's not that simple when figuring out carbon. It creates some challenges.

Ed: It does. And it's an area that's improving. Carbon data is getting pretty reasonable now. You ultimately have three different flavors, I suppose. So scope (1) is the carbon the company produces itself. Scope (2) is the carbon it produces making its product, and scope (3) is how its product is used. So if you think of a car manufacturer, scope (3) is everyone driving their cars around. Now scope (1) and (2), what the corporate produces themselves and their own manufacturer is getting pretty reliable. Scope (3), how the end product's used is pretty reliable for some industries. There's still a lot of opaqueness in certain, particularly around, for example, the banking sector, we're getting that link to where do banks actually lend. And therefore, the carbon is being produced as a result of their lending. That isn't really there yet, but clearly is a work in progress.

So, you actually do have a pretty reasonable starting point and you've got to start somewhere as well, because this is not something that's going away and you can't really sit on your hands and just say, we'll wait five years for the perfect data, because then the market will have moved away from you anyway. But if I'm thinking of the sort of analytics that you can look at. So, if you look to actually, where does carbon sit in the US credit market? Actually it sits in utilities and energy companies. And what do utilities and energy companies do? They issue a lot of long dated debt. So, if you're a life insurer, you're probably sitting on these 20-year-plus bonds that are in high carbon intense industries, and we've done this analysis for US insurers. And actually, if you run their portfolios off over time, actually the carbon intensity is going up in their book rather than down, because actually they've got their carbon at the long end.

And it's beginning to get your head around these kind of concepts that actually, perhaps what you're going to do is you rebalance your portfolio going forward when credits mature, you've got money to reinvest, actually, perhaps you don't stick it at the long end of the curve in terms of where your carbon exposure is, you start bringing it closer forward. So you don't become a forced seller of carbon at some point in your net zero journey. We've also worked with other insurers who have done quite a blunt approach of just literally saying, we're not going to sell our current portfolio, but we're not going to invest in any more heavy carbon intensive industries for the time being until we've got our head around the analytics and how this actually works. So, there are definite easy steps you can make, whether it's on the exclusion side, avoiding high carbon, when doing the analytics to make that gradual change. And we are only talking about 5% per annum in terms of carbon reduction to be on a net zero pathway.

Stewart: But to some extent, human nature is to kick the can down the road. Hey, I'm five years from retirement. So 28 years' a long time. Hey, let's do some things now and let's head in that direction. But if the magnitude of the capital that you talked about earlier on this podcast, and this is a long, long dated statement, I guess, but as you get closer to these net zero dates, I've got to think that there's going to be, you're going to have a lot of selling pressure on heavy carbon investments, because people will back load that compliance component. It seems like that being ESG and climate concern now and moving in that direction purposefully is going to result in a good long term investment result if the capital flows and capital commitments paying out. Does that make sense?

Ed: I'm just trying to think that through in my head. So in effect, by investing in the lower carbon companies today, you should benefit in the long term. Yes, because you won't become a forced seller. And ultimately the way that those names should be the ones that outperform, particularly if you're in a sector like energy, for example, where people want to keep investing in energy, but they want to find the firms that are on the right carbon trajectory. It's something that we actually build into our fundamental analysis now, which is really cool, which is actually you take the world's 200 worst carbon emitters, and you say based off all of their public fine and things and everything you know about them, what is their current trajectory to net zero? Or sorry, no, what is their current carbon trajectory? Because most of them haven't signed up to net zero clearly.

And actually by doing that, you're able to say, actually, these are the ones who are going to be the winners, because company X has no plan in place for example. And we need to engage with them to get a plan in place, but because they have no plan in place, clearly their carbon footprint's going to be not reducing at least, whereas company Y signed up to net zero, is putting all these plans in place. Actually they're going to be the favored one for people to invest in, because they want to be in energy and they want to be low carbon as well.

Stewart: As poorly stated as my question was, your answer is spot on. You're using the carbon trajectory as an input to your fundamental analysis, which I think is really interesting. If I can go back to one other point you made in the podcast, you talked about your modeling capabilities for insurance companies. Anyone who knows much about this business knows that there is a substantial commitment of resources to build those modeling capabilities, particularly where it comes into sustainability. Can you talk about Robeco's modeling capabilities and how you can help insurers look at their ESG exposures and how to assess it?

Ed: So I think when you look at insurance asset managers more broadly, clearly an insurance asset manager brings the economics, the forward looking view, or their own forward looking view can build in capital requirements and AIC rules, LBC, ultimately constructing a portfolio that is optimized under an insurance regime. And I'm sure every insurance company has seen God knows how many optimizations of their capital position against what they're investing in and what is their liabilities. I think that the thing that we do that is very different is, if you think back to our history, we used to calculate our own ESG data, so that's 20 years of creating your own database on what within ESG adds additional performance. So, you can clearly just buy data from providers, there's several providers out there. We buy data from ESG data providers as well and carbon data providers as well. But it's having that team of people who really understand what is in the data and what is relevant. So we have a team of 12 who just analyze data. That's all they do, analyze ESG data, carbon data, that's their day job.

And the way I always look at it is, if you ever speak to any fixed income investor, they will always tell you they do their own in depth research and they do not invest just based off what a credit rating agency says. And ESG is the same because you can take a provider's data and you can put those in as constraints for a portfolio manager, but that doesn't mean they understand why they got those ESG scores in the first place, or how they pick within those ESG scores, or carbon scores, who is actually going to be the winner of tomorrow, who's going to add additional returns. So, that's what we do from the research side. And, then you look to the analytics side. So optimizing that within our portfolio.

So if you're talking a fixed income portfolio, we integrate our fundamental credit view into our fixed income portfolio construction. So it already has our ESG view within there. And then on top of that, we can build in other constraints. You want to reduce carbon in your portfolio by 5% per annum, we can build that trajectory into your fixed income portfolio. We can do the same in your equity portfolio, or pretty much any other part of your business. The other one that really, as well, I think, comes to the fore is people wanting to make a broader impact. There was something else that actually really came through in our survey. We asked people in terms of what ESG approaches and strategies are using to incorporate sustainable investing into your investment process.

And last year, when we did the survey, the thing that came up top was full ESG integration. And full ESG integration to my mind is how do I add alpha from ESG ultimately? So it was all about investment return. And that's actually dropped down to number five now. And the things that have come to the top are things like thematic investing, climate change, impact investing, and these are all about wanting to do good through investments. That's a slightly different criteria. That doesn't mean worse performance, it just means you've actually got a real goal. And then actually building that into the modeling, that's when it's really exciting. So, recently we've been working with UK insurers who have picked a number of the UN sustainable development goals. So they've decided across the 17 sustainable development goals, climate action means something to them, health and wellbeing, number (3), that means something to them. They want a structural overweight in their public credit portfolios to firms that have a positive impact against those sustainable development goals.

And we can actually build that into our modeling and our portfolios and say to you “Insurance company, this will be your expected impact on returns by having that positive choice in your investment philosophy”. And that's really only just been coming to fore in the last six months, but it's super exciting when you start thinking actually you can just build all these great sustainable blocks and say, actually ask the question “Am I giving something up by having these sustainable beliefs,” or being able to quantify that. And, I think that is unique in the asset management industry.

Stewart: Doing well while doing good. I just think that is really an amazing capability and one that I think it's worth really pointing out. So, as usual, I'm the person who learns the most on these podcasts. I've learned so much from you Ed. Thanks so much. I just think that, I think a lot of people don't know how long Robeco has been in the ESG space and how long you've been on this. This isn't something you all picked up the other day and thought was a good idea. You've been doing it for a long time and you're leaders in this space. And I appreciate you sharing everything, all of that information with us. And so thanks for being on.

I've got one more question for you. This is the ‘ask me anything’ portion of the program. I want to take you back—I've taught for a long time, so this is why I ask the question. I want to take you back to the day that you graduated from your undergraduate institution at college and you are there, they call your name. You walk across the stage. The crowd is going bananas. You get a quick shot with the president, get your diploma, down the other side of the stairs you go and you run into yourself today. What do you tell your 21 year old self in this market environment? What advice would you give him?

Ed: I'd have told myself to go back and do a different degree.

Stewart: What was your degree? I'm sorry. I don't know.

Ed: It was maths. I like maths. That's fine. I would actually buy background, but yeah, there were more fun degrees I could have done.

Stewart: There you go. All right. Well that's good. Ed, thanks for being on.

Ed: No, no thank you, Stewart. It was great to speak to you today.

Stewart: All right, listen. Thanks for listening. If you have ideas for podcasts, please email us at podcast insurance@insuranceaum.com. My name is Stewart Foley and this is the Insurance AUM Journal podcast.

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