Why life insurers are investing with ESG in mind

Image of dark night with lightning above stormy sea — © Sergey Nivens / 123RF Stock Photo

Flooded basements in Ontario, entire homes lost to wildfires in British Columbia, out-of-control hailstones pummelling Prairie buildings—it’s obvious why property and casualty insurers want to mitigate climate risk through ESG investing. As we face more extreme weather events, they face more claims. What isn’t so obvious is that life insurers do as well.

Three years after the 2014 flooding in Burlington, Ont. that affected 3,500 homes, nearly half of residents from flooded households still worried when it rained, a 2018 Manulife study found. And if climate change continues along its current path, life insurers could face more than an uptick in mental health claims.

“If we hit the two-plus degree temperature increase, you’re going to see potential for diseases to expand out of their historical geographical concentration,” says Randy Brown, chief investment officer at Sun Life.

“As temperatures change, mosquito-borne diseases might move into areas where people haven’t built up immunity. You could see more pandemics.”

That would mean an unprecedented level of claims for companies like his.

Climate risk also affects life insurers, like all institutional investors, in terms of their portfolios. An insurer might hold real estate or infrastructure assets that are vulnerable to extreme weather. And even if its holdings don’t take a physical hit when the hurricane comes, an investor might suffer indirectly.

Brown points to an Amtrak study that found sections of its Eastern Corridor track are at extreme risk of flooding and permanently closing. Rising water in coastal cities such as New York and Miami would disrupt the free flow of goods, hurting the wider economy.

Investors have a fiduciary duty to consider all material factors that could affect a fund’s performance when selecting and managing assets, says Dustyn Lanz, chief executive officer of the Responsible Investment Association.

Adds Laura Zizzo, chief executive officer of climate risk consultancy Mantle: “The understanding of fiduciary duty shouldn’t only be based on short-term profits—insurers have to look at some of these longer-term considerations as well.”

If they don’t, there could be legal repercussions. Directors and officers who do not mitigate climate risk in their investment decisions—rather than those whose decisions don’t pan out—are more likely to attract liability, University of British Columbia law professor Janis Sarra wrote in a 2017 paper. The court may order a variety of remedies, including replacing directors, compensating shareholders and setting aside transactions.

Beyond the E

Climate risk is only one part of ESG principles: societal and governance factors are equally important. A 2018 BlackRock study found that, among ESG sub-topics, 83% of global insurers rank business ethics as very or extremely important. Almost as many find labour policies (80%) and product liability (76%) to be.

“It comes down to creating a longer-term sustainable environment for these companies to thrive,” Brown says. “There are two different lenses you need to have. There’s an economic lens where we would say that investing with companies that have strong ESG practices leads to better economic outcomes in the longer run. Then there’s the moral lens on the issue. If we, as a holder of large pools of capital, can deploy that capital in ways that are better for society, ultimately everybody wins.”

Brown points to sustainable wages and ethical treatment of workers as an example of an important ESG factor. After the 2008 financial crisis, lower earners’ wage growth lagged behind inflation, and the wage gap grew, creating enormous class tension.

Because of that, “you’re seeing more populist, more nationalist views coming out globally because people feel left behind,” he says. “It’s in all of our best interests for people to feel included in the capitalist system and therefore create a better functioning, smoother, less volatile environment.”

Taking action

So how can investors do that? For its part, Sun Life evaluates a company’s ESG profile just as it considers its financials, growth models and management team. It also isn’t set on exclusionary screening, whereby it would opt out of all assets in a certain industry on principle.

“Screening remains an important approach for ethical or values-driven investors, but it is one approach of many,” Lanz says. More common is shareholder engagement.

“We think if you just do an exclusion list you’re missing the point,” says Brown.

“It’s not like taking a snapshot and a company’s good or bad. It’s really about where they are going. If you have a management team committed to innovating and moving away from that legacy to something more sustainable, I would say we would probably want to support them in that journey.”

Quebec-based SSQ Insurance, which works in both the P&C and life markets, tracks the companies it has invested in through an external ESG platform.

“We’ll see if there have been any controversies,” says investment analyst Carl Morin. “Have they gotten into any trouble? If they did, are they managing the situation? Do they have a sustainable development policy internally?”

Red flags will prompt a thorough investigation but like Sun Life, SSQ won’t automatically pull its funds if it doesn’t agree with a company’s actions.

“We understand in some sectors, it can be hard to be 100% perfect, but if they’re taking matters in hand, if they have policies in place, we will watch them. It won’t necessarily mean we’ll liquidate our position,” Morin says.

Because SSQ primarily invests in corporate bonds, it lacks the influence of activist shareholders. To ensure its opinion is heard, Morin says, it would work with external partners who are significant shareholders to communicate with the company.

Whichever path insurers choose, they may think that following ESG principles limits their investment choice and level of returns. The BlackRock study, for instance, found that 37% of global insurers believed they would lose some excess return because of a commitment to ESG factors.

But Zizzo argues that fear is unfounded. “If you’re talking about a full divestment in three years, you could look at some short-term risks associated with that,” she says. “But if you have a more pragmatic approach, integrated in a meaningful way, hopefully you’d mitigate that short-term and long-term risk. It depends on how you’re shifting your portfolio. … You just need to be smart about your investment decisions.”