The insurer transparency / sustainability challenge
30th January 2024
Driven by rising rates and solid investment returns, around £50 billion of DB pension scheme assets and liabilities were transferred to the insurance market in 2023 and even more is forecast for 2024. Facilitating this shift is historically strong pricing from a small number of regulated UK insurers, who are therefore having to manage historic levels of inflows.
At the same time, both schemes and insurers are incorporating sustainability into their policies, strategy, risk management and investments. The newly released Sustainability Principles Charter aims to bring these processes together, and with Cardano a founding partner in the development of the Charter, we strongly support its aims.
This Charter was developed with the intention to aid trustees in understanding two core principles before undertaking (or monitoring) a transaction with an insurer:
- How does the insurer’s approach to sustainability match or exceed the approach the trustees have worked so hard to develop; and,
- Is the insurer exposed to more risk than peers or the existing employer covenant due to its stance on sustainability?
Engaging with sustainability teams
Since beginning to provide sustainability reviews in 2019, we have observed UK insurers developing their internal sustainability teams. These teams are generally committed to improving their organisation’s sustainability through developing robust policies then integrating these into governance and investment decisions. In many cases, this is likely to place insurers in a better position than the aims of pension schemes they are looking to receive assets from.
However, without direct engagement with sustainability teams in the insurers, information on their internal approaches can be very limited as public disclosure requirements remain minimal. Moreover, we find that insurers are continually updating their approach, for example in credit risk assessment or preferred illiquid asset classes, and engagement must therefore be an ongoing process. The Charter aims to directly address this issue through encouraging clear and regular information sharing across key categories like values, investment appraisal and future policy changes.
Comparability of insurers is another critical issue that can limit trustee understanding of the suitability of an insurer for their buy-in or buy-out. Data can be idiosyncratic, policies may seem at odds across insurers, and their evolution over time or business area might not be clear. The Charter seeks to address these issues by encouraging clarity of information, provide a framework to encourage comparability and highlighting that trustees have a real interest in how their chosen insurer implements its aims over time, at least until a full buy-out is achieved.
Underestimating climate risk
On the second consideration, around risk, trustees may at first overlook the impact on insurers of sustainability but it remains one of the only major structural risks which insurers do not yet explicitly or consistently assess and provide for.
The Prudential Regulation Authority (PRA), which oversees UK insurers, has highlighted that insurers have to improve and must “understand and disclose the financial risks associated with climate change. This should involve scenario analysis and stress testing to identify and disclose short- and long-term climate-related financial risks.” The European Central Bank, for its part, has suggested that European insurers could face losses of more than 15% on corporate bond portfolios from climate change and urged financial institutions to increase capital to withstand these emerging risks.
While the PRA will continue its oversight of those insurers, and will likely improve understanding and provisioning over time, the current imperfect oversight and heightened risk highlights the need for trustees to properly assess these risks. To do that, they require information: on the assets and liabilities of the insurers; on their approach to sustainability policies; on how they provide for or mitigate those risks; and, on how they see this changing over time. The Charter provides trustees with a framework, pre-agreed by the main insurers, for gathering that information which trustees can then assess directly or seek professional advice on.
Trustees will undoubtedly continue to transfer scheme liabilities to the insurance industry – the Charter should help them ensure that when they do so they properly include sustainability in that process.
Trustees will undoubtedly continue to transfer scheme liabilities to the insurance industry – the Charter should help them ensure that when they do so they properly include sustainability in that process. Only then can trustees be said to fully understand their counterparties before making arguably their biggest decision since the scheme was first established.