InsuranceERM Annual Awards 2021 - Americas

Solving the ESG conundrum

Managing ESG is more important than ever. Conning's Matthew Daly, head of corporate and municipal teams, and Matt Lightwood, director of risk solutions, talk about what insurers should be doing in addressing this key area

Why are environmental, social and governance (ESG) factors so important for insurers at the present time?

Matthew DalyMatthew Daly: Several forces are increasing insurance company focus on the role ESG plays in investment portfolios. A thorough consideration of material ESG factors provides a superior, more holistic understanding of holdings in the investment portfolio. These factors can exert a material influence on both the fundamentals, as well as valuations of holdings. Various constituencies are also demanding a better understanding of the assessment and management of these factors; this includes company management, the equity and fixed income community, customers, suppliers, regulators, and rating agencies. As an example, some key regulators are pushing insurance companies to better demonstrate an awareness of the financial risks associated with climate change.

Which specific areas of ESG is Conning helping insurers to tackle right now?

Matthew Daly: Conning has been helping our clients understand how ESG factors are considered in their investment portfolios. We've taken great measures to assign our own proprietary ESG assessment to issuers across our corporate and municipal holdings. These factors are integrated into our proprietary credit assessments, and then by extension we utilise these to better assess the relative value of securities. ESG factors not only highlight risks, but also can uncover investment opportunities. We've developed extensive reporting capabilities to assist our clients in understanding and reporting on ESG and climate-related risks in their portfolios. Reporting tools include our proprietary ESG assessments, as well as third-party vendor data related to ESG ratings, carbon emissions, and transition risk. This allows us to provide customised solutions to clients depending on their desire to manage portfolios to achieve unique preferences for climate-specific goals.

Conning has also been involved in the field of software products to manage risk on the asset side. What has been driving that?

Matt LightwoodMatt Lightwood: Yes, Conning started to see a lot of demand from the industry for a solution that would help insurers understand the effects of certain climate scenarios on their risk measures on the asset side, and there were several drivers for this. Initially, we started to see external pressure from the regulators — for example the PRA in the UK with their exploratory climate-stress-test exercise — but now this has really exploded globally with state regulators taking the lead in the US.

What is interesting, though, is that in some companies we are seeing this blossoming from within. Firms are starting to understand that climate risk relates to other types of risk - reputational risk, litigation risk, and elements of operational risk, for instance. Finally, for us at Conning, our own asset management team was driving us on the quantitative risk side because of demand from our clients for TCFD reporting and because of our own aims around PRI (Principles for Responsible Investment) and other initiatives.

There must still be quite some degree of uncertainty about how climate change will develop and how it will affect consumption, GDP and investment returns. How do you account for this uncertainty?

Matt Lightwood: There is no really robust way of pinning economic and financial market effects on a particular climate scenario. Conning believes that trying to understand the distribution of possible outcomes is key. A transition to a low-carbon economy, for instance, may have the potential for upside as well as downside, and could spur innovation as well as fiscal stimulus. A deterministic stress test doesn't really tell you anything about that, so we've been developing techniques which model the range of outcomes using the stochastic modelling techniques that we are already expert in. This really helps us to acknowledge and work with the uncertainty in our knowledge of the future market impacts of climate risk, and avoid the pitfalls of false precision.

Does the company have any ESG initiatives that you are working on for this year?

Matthew Daly: One of our key initiatives relates to transition risk. Different industries and issuers are more or less exposed to the transformation and transition of the economy as we march towards a lower carbon emissions world.

Conning's analyst team is developing its own proprietary rating system to ensure that we have a thorough assessment of the implications of transition risk for both industries and issuers. Specifically, this entails a deep understanding of the risks and opportunities associated with changes in policy, regulation, and technology in a low-carbon economy. This information is utilised to further enhance our assessment of the financial risks companies face from climate change, as well as highlight any potential areas of investment opportunity.

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