Sustainable Finance for Insurance Companies

MSFI sustainable finance workshop

24 March 2022

Agenda for today

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Sustainable Finance for Insurance Companies

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Workshop objectives

1. Understand the demand and growth opportunities for sustainable finance
2. Understand the potential sustainability and ESG risks and opportunities for insurance companies
3. Integrate sustainability considerations and ESG factors into investment decisions and product design

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Speaker

Arina Kok

Partner, Climate Change and Sustainability Services, �Ernst & Young Consulting Sdn Bhd

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Rebuilding a sustainable and inclusive recovery post COVID-19 through sustainable finance

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Source: ¹EY Thought Leadership : How will ESG performance shape your future?; ²EY Center for Board Matters, 2021 proxy season preview: What we’re hearing from investors

The COVID-19 pandemic, along with increased focus on climate change risks, has highlighted the importance of ESG in investment decisions

In your opinion, do companies adequately disclose the Environment, Social and Governance (ESG) risks that could affect their current business model?¹

Percentage of respondents who say that companies do not adequately disclose the ESG risks that could affect their business models

In the past 12 months, how frequently has a company’s nonfinancial performance played a pivotal role in your investment decision-making? ¹

52% investors identified climate risk and natural resource constraints to be the top three biggest threats to strategic success in the next three to five years

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85% investors identified workforce diversity in terms of gender, race and ethnicity to be of greatest value to them as they assess human capital management

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98% investors signaling a move to a more disciplined and rigorous approach to evaluating companies’ nonfinancial performance

60% millennial employees are willing to take a pay cut to work for a socially responsible company

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USD 18 trillion global aggerate income by 2030 by millennials, a group inclined toward environmentally friendly purchases

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Trends that are placing ESG issues on the minds of governments, business owners, investors and the wider community today ²

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Source: 1: AmAssurance COVID-19 Test Fund (CTF), 2: Chubb Environmental Impairment Liability Insurance in Malaysia; 3: Manulife COVID-19 Test Fund (CTF)

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COVID-19 became the catalyst for sustainability-linked insurance products

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Overview of sustainable finance market in the insurance landscape

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1.1

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ESG goals provide guidance for sustainable business decisions

What are the main drivers of sustainable finance?

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Stakeholders’ expectations on insurers’ role in sustainability and sustainable finance

Customers

The next generation of customers expects our products and service to contribute to society:

• Consumer products marketed as sustainable grew 5.6 times faster¹
• 61% willing to pay more for sustainable products¹
• The median saver would prefer a sustainable fund even if it means having to sacrifice up to 2.5% of annual returns²

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Investors

Large investors and rating agencies are focusing more on sustainable finance:

• Funds and stocks with high ESG scores outperform the broader market and trades at higher valuations³
• Pressure around voting practices is rising steadily, especially around climate change

Source: ¹NYU Stern’s Center for Sustainable Business, ²University of Cambridge Investment Leaders Group, ³Bloomberg Green 24/09/2020

Regulators

Increasing trends in regulatory and supervisory requests, focusing on:

• Sustainable finance regulations including investments, non-financial reporting and disclosures
• Climate risk and the disclosure according to recommended frameworks like TCFD
• Supply chains, including human rights

Society

Civil society and non-profit organizations such as the Principles for Sustainable Insurance and the Net Zero Insurance Alliance, are important stakeholders for insurance organization to interact with on a regular basis.

There are also increased interest from campaigners such as WWF and Greenpeace around insurer’s climate strategy and approach.

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Source: ¹EY Center for Board Matters, 2021 proxy season preview: What we’re hearing from investors; ²Consumers demand greener products in wake of pandemic (circularonline.co.uk); ³Climate Action Tracker: “Paris Agreement turning point. Wave of net zero targets reduces warming estimate to 2.1°C in 2100. All eyes on 2030 targets.”; ⁴BlackRock Client Letter

With stakeholder expectations growing, there is also rising interest in ESG dedicated products

Climate change is seen as a top three challenge to negatively impact business growth (32% of CEOs, 28% of boards, 44 % investors)¹

Four out of five (80%) consumers say they are planning to purchase goods and services fromm businesses they know have made a concerted effort to be environmentally friendly²

127 governments, responsible for more than 60% of global emissions, are considering or already implementing commitments to net-zero³

From January to November 2020, investors in mutual funds and ETFs invested USD 288 billion in sustainable assets, a 96% increase over 2019⁴

60% of millennials would take a pay cut to work for a responsible company¹

Regulations are becoming stricter (EU/ETS for GHG emissions; Circular economy (eco-design); Green, Carbon and Border taxes, EU Taxonomy)

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Regional and national initiative in support of sustainable finance

Private equity and venture capital funding for green and circular economy

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ASEAN Taxonomy for Sustainable Finance¹

• The ASEAN Taxonomy acts as a map to help guide capital toward activities that can promote the transition of activities in the real economy onto a more sustainable footing.
• The ASEAN Taxonomy will be the overarching guide for all ASEAN Member State, complementing their respective national sustainability initiatives and serving as ASEAN’s common language for sustainable finance.
• The taxonomy aims to help ASEAN members states governments and investors to identify suitable economic activities in the Southeast Asian context and direct investments to fill a significant regional green financing gap.

Source: ¹ASEAN Taxonomy for Sustainable Finance, ²MEFIN Network Website

Mutual Exchange Forum on Inclusive Insurance (MEFIN)²

• The MEFIN Network is a collegial body of insurance policy makers and regulators in Asia with memberships from the insurance industry.
• The network serves as a mechanism for the exchange of knowledge and ideas essential for the formulation of enabling policy, regulatory and supervisory framework taking into consideration of the unique legal and regulatory environment of respective country in Asia.
• MEFIN aims to promote social and economic development in the region through globally accepted regulatory and supervisory standards of the insurance industry.

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Mutual Exchange Forum on Inclusive Insurance

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Source: ¹Principles for Sustainable Insurance; ²ESG Integration Framework

Insuring the climate transition: Principles for Sustainable Insurance

Allianz’s screening process for ESG issues in insurance and investment transactions

Case Study: Implementing the principles²

Planned insurance/ investment transaction

Business unit screens

Does sensitive business areas/ countries apply?

No further action required for ESG

Business unit applies ESG Sector Guidelines or Human Rights Guideline for Sensitive Countries

Are potential ESG risk detected?

Referral to appropriate ESG center for competence

ESG Assessment

ESG approval

ESG conditional approval subject to further information or mitigation measures

Declined for ESG reasons

Yes

No

No

Yes

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The greening of insurance product and services

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Sustainable insurance products offered

Source: Capgemini Invent – Sustainable Insurance

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Case study: Insurance industry to close the protection gap

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Massive natural catastrophe-related protection gap now accounts for US$221billion �in 2020, �with catastrophe losses at 29%

Key trends in closing the protection gap

Source: EY : How the insurance industry can boldly shape a more sustainable future; EY: How insurance changes can tackle some of the world’s biggest challenges

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Integration of ESG factors in investment decisions and product design

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Building resilience through sustainable finance

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2.1

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Macro trends driving risk landscape evolution

• Rising healthcare costs are a major concern. Other aspects that contribute to this bigger trend include increasing resistance to antibiotics, new viral threats, and escalating lifestyle-related issues.

• Financial, regulatory and monetary policy risks continue to loom over the industry and, along with geopolitical risks and increasing protectionism, pose a potent threat to steady operations. The emergence of tech-based firms and new business models also creates risks that can’t be overlooked.

• The advent of the latest technology, such as artificial intelligence, connected devices and nanotechnology has not only exposed humans to risks related to data security, but is also altering the very nature of risk itself.

• Concerns about the increasing frequency and severity of cyclones and wildfires, scarcity of natural resources, and increase in micro pollutants (including plastics) are growing.

• The lifestyles of different demographics vary widely and keep evolving. Society is also changing rapidly, with growing inequality, a weakening social fabric, and a shift in demographics (for example, the silver tsunami and an increasingly tech-savvy population).

Macro

trends

New medical and health concerns

Disruptive environmental patterns

Technological advancements

Evolving social and demographic trends

Changing business environment

Source: Capgemini Invent – Sustainable Insurance

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Source: NGFS Call for Action Report 2019; Climate Change and Principal-based Taxonomy discussion paper, BNM

Climate change as a source of economic and financial risks

Credit

Physical risk

Transition risk

Climate-related

Environmental

Climate-related

Environmental

• Extreme weather events
• Chronic weather patterns

• Water stress and pollution
• Resource scarcity

• Policy and regulation
• Technology and innovation
• Market sentiment

• Policy and regulation
• Technology and innovation
• Market sentiment

Risks affected

Operational

Other risks (liquidity, business model)

Market

The probabilities of default (PD) and loss given default (LGD) of exposures within sectors or geographies susceptible to physical risks my be impacted

Shifts in market expectations which could result in sudden changes in pricing, higher volatility and losses in asset values in some markets

Physical damage to operation’s property, branches, data centers due to exposure to extreme weather events

Higher insurance policy/takaful certificate cancellations by holders to supplement lost of income

Carbon intensive industries (stranded assets) and assets that turn out to be less green as initially expected

(green washing), which may lead to higher PD as well as lower collateral values

Transition risk drivers may generate an abrupt repricing of securities and derivatives, for example for products associated with industries affected by asset stranding

Changing consumer sentiment in relation to climate issues can risk organizations of lagging behind new green activities and technologies

Transition risk drivers may affect the viability of some business lines and lead to strategic risk for specific business models if the necessary adaptation or diversification is not implemented

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The integrated dimensions of sustainable finance – hitting the full business model of a financial institution

Business implications and challenges

Changed shareholder goals

New or changed risks

New terminology

New investment products

New risk concentrations

New risk dependencies

Changed service partner behavior

New business activities

Changed employee behavior

New data

Changed policyholder behavior

Changed business partner behavior

New market opportunities

New regulatory requirements

Business implications and challenges

Embed ESG risk in risk management

Counterparty analysis

Management reporting

Product innovation

Source: EY research

Legend: COO – Chief Operating Officer; CEO – Chief Executive Officer, CFO – Chief Financial Officer; CRO – Chief Risk Officer; CIO – Chief Information Officer; CA – Chartered Accountant; CUO – Chief Underwriting Officer; CSO – Chief Sustainability Officer

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Source: EY analysis

Various strategies for sustainability ranging from creating new products to introducing new policies can be implemented by Insurance Companies

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Insurance companies are increasingly responding to growing appetite for ethical and sustainable practices by creating ESG products for customers.

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For example, Tokio Marine Group offers Cyber Risk Insurance, which contributes to smooth business activities through new products and services.

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Most industry players are transforming their internal operations to become more inclusive and environmentally friendly.

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For example, Allianz has established dedicated ESG Task Forces to integrate sustainability matters across the core processes in the organization.

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Insurers are investing in projects/companies/organizations/funds that bring about positive social and/or environmental impact.

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AIG has a total of $3.2 billion invested in private wind; solar; geothermal and hydroelectric generation and transmission projects; solar power purchase agreements (PPAs).

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Insurance companies are increasingly adopting sustainable ways of distribution of services to their retail customers.

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Allianz Taiwan Life Insurance created an AI powered virtual assistant that can interact with customers in a very human way.

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External partnerships undertaken by insurers to offer a wider range of integrated ESG solutions to their customers.

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For example, Allianz collaborated with International Finance Corporation (IFC) to support the global transition to a low-carbon economy across market as well as serving the customer’s interest.

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To incorporate and integrate ESG into their operations, insurers are signing up to various frameworks and strategies to better acknowledge the ESG-related causes.

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Manulife developed Municipal Bond ESG framework, to analyse ESG risk in their municipal and securitised fixed-income assets.

Product

Internal

Impact investing

Distribution

Collaboration

Policy

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Achieve risk-adjusted, long-term financial returns through integrating sustainability risks and opportunities into investment decisions

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Training

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Provide adequate and regular training to understand the economic importance and financial materiality of ESG risks and opportunities.

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Enhance asset managers’ awareness of risk and opportunities linked to ESG factors when making decisions on securities and asset selected.

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Access to information

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Provide portfolio managers and investment analysts access to ESG platforms and relevant information such as ESG analysis, ratings and data.

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Encourage portfolio managers to leverage on ESG research and analysis provided by brokers in investment securities and asset selection.

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Process integration

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Clear understanding of the process to integrate ESG considerations in asset valuations and decision-making process for a certain security of asset.

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Integration of ESG risk exposure, and exposure to controversial business practices into security selection decisions process.

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Integration of ESG factors into industry sector analysis.

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Active ownership

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Actively manage portfolio and establish dialogue with stakeholders to support identified responsible investment matters.

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Work closely with portfolio managers, ensuing requirements for ESG integration are reflected in the investment process.

Source: Responsible Investment at Zurich, June 2021

Case studies from sustainable finance strategies and commitments of insurance companies

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Source: UN Global Compact: SDG Industry Matrix

Types of sustainability commitments, goals and targets that can be set

Sustainable development commitments

Decarbonisation commitments

Illustration of decarbonisation commitments

Carbon neutral

Carbon negative

Net-zero

Science-based target (SBT)

Emissions = offsets/ removals

SBT set and residual emissions < offsets/ removals

Paris-aligned greenhouse gas (GHG) reduction target

SBT achieved and residual emissions = removals

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Source: : UN Environment Program Financial Initiative (UNEPFI) Net-Zero Insurance Alliance (website)

Case Study: Global insurance leaders joins newly formed Net Zero Insurance Alliance

Description

Benefits

Impact

• Eight leading insurers joined Net Zero Insurance Alliance (NZIA) convened by the UN Environment Program’s Principle for Sustainable Insurance Initiative (PSI), contributing to the goals and activities of the UN Race to Zero campaign and the Glasgow Financial Alliance for Net Zero.
• NZIA is a net-zero network for the underwriting business to underline the importance of cooperation's between leading governments and companies to mitigate the risks of climate change.
• Member of NZIA will set measurable and science-based climate targets, which will be updated every five years. The first target is expected to be reached by 2025 and all members will report annual progress.

• Members of the Alliance believe the global insurance and reinsurance industry can play a key role in the transition to a resilient, climate friendly economy, in line with Paris Climate Agreement's target.

• Industry players will work together with insurance associations, regulators, trade bodies, the UN and other intergovernmental organizations to promote the goals of NZIA and to seek consistency of regulatory, supervisory and governmental policy frameworks with net-zero transitions.
• Members of NZIA will develop and offer insurance and reinsurance products, solutions and arrangements for low-emissions and zero-emissions technologies and nature-based solutions that are key to the net-zero transition.
• The alliance will advocate for and engaging in governmental policies for a science-based and socially just transition of economic sectors to net-zero.

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Source: : Allianz press release

Case Study: Allianz Global Investors (AllianzGI) sustainable investment drive

Description

• In March 2021, AllianzGI, one of the world’s largest active investment managers, announced an additional 74 equity, fixed income and multi-asset funds that would become sustainable (EUR 70 billion assets under management).
• The portfolios will be constructed using ESG assessments reflecting clients’ values through AllianzGI Sustainable Minimum Exclusions* and will adopt a new strengthened engagement approach or socially responsible investing (SRI) Best-in-class considerations.
• AllianzGI also launched a new stewardship strategy: Climate Engagement with Outcome approach.
• The strategy aims to engage with companies on the climate transition pathway toward a low carbon economy, where fund managers will actively engage with the top 10 absolute carbon emitters (scope 1 and 2) within their portfolio as a proxy for climate impact.

• AllianzGI’s efforts could help to shape the asset management landscape, by innovating and anticipating growing client demand.
• The new stewardship strategy aims to set engagement targets with a company (e.g., GHG reduction targets or board level remuneration targets linked to climate change). Issuers which do not respond to requests or fail to show an improvement effort in their climate pathway will have divestment considered in the escalation process.

Benefits

• AllianzGI believes asset managers should take a more active role in shaping the future/responding to climate change. Its new proactive stewardship approach aims to help open this dialogue with companies and encourage them to share these views.

*the exclusion list (~900 on a global basis) includes companies with links to controversial weapons, demonstrate severe controversies with respect to the United Nations Global Compact, and earn a significant share of revenues from coal and tobacco or weapons

Impact

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Case Study: Mongolian Index-Based Livestock Insurance Project (IBLIP)

Description

• Traditional insurance is often not available in sparsely populated areas of Mongolia.
• Livestock are exposed to extreme climatic conditions, which increasingly threaten rural livelihoods.
• In 2005, the Mongolian government entered into a credit agreement with the World Bank to implement the IBLIP, an index-based insurance program. It incorporated “risk-layering”, whereby:
• Individual herders bear the cost of small losses (first 6%) that do not affect the viability of their business.
• Larger losses are transferred to the private insurance industry (next 24%).
• The final layer of catastrophic loss (above 30%) is borne by the government.
• Insurance is provided through partnering with local private insurance companies.
• IBLIP pays out whenever the mortality rate exceeds a specific threshold.

• Combines self-insurance, market-based insurance and social insurance:
• Herders are incentivised to manage and invest in their livelihood activities
• Low administrative cost for insurance companies
• Secures indemnity payments to insured
• Opens the market for private innovation and reinsurers

Benefits

• IBLIP can provide financing for adaptation projects related to climate change, by lowering the cost of the insurance to cover low-income markets.
• Since inception in 2006, the IBLIP premium has increased every year, reaching a total premium of MNT 1.8 billion (~ USD 0.63 million) in 2013, with voluntary participation of 19,447 herder households (~13.5% of total) from 21 aimags (provinces).

Impact

Source: UNESCAP presentation on Innovative instruments for Green Finance; The Professional Consortium article

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Case Study: MS&AD’s ESG consideration in insurance product design

Description

• MS&AD developed its internal process for underwriting to confirm transactions are in accordance with the content stated in the Group Policy for business activities with consideration for sustainability and underwrite and make investments only relevant projects aligned with MS&AD’s ESG Assessment/Confirmation of Compliance with Group Policy.
• MS&AD has established an escalation process for projects that are considered to be in compliance with the Group’s policies but are deemed to have high sustainability risk. Such transaction are reported to the Group Sustainability Committee based on the judgement of the senior management of responsible section for ESG.

Benefits

• Product and services aimed at further contributing to the resolution of social issues reached about 51.7% of premium written in the non-life insurance business in FY2020.
• MS&D will not undertake projects related to the construction of new coal-fired power plants or underwrite or invest in companies that manufacture cluster munitions, which are inhumane weapons.

Impact

• MS&AD Insurance Group (MS&AD) integrated the 17 Sustainable Development Goals (SDGs) into its products and services to support the industries required to realize a sustainable society.
• MS&AD is contributing to the achievement of Sustainable Development Goals through risk consulting services, insurance and other services.
• The group has underwriting criteria adapted for respective product and service as part of risk assessment process. Comprehensive process including system verification has been implemented and underwriting decision including the board’s approval are made based on ESG risk evaluations.
• The group examines the value generated by the product and services and strive to create value shared with society.

Source: MS&AD Holdings Sustainability Report 2021

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