In the not-too-distant past, insurance professionals used to understand ESG to mean ‘economic scenario generators’. Today, there is no risk of confusion anymore with a wave of Environmental, Social & Governance (ESG) concerns having swept over the industry, both on the underwriting and asset management sides of the insurance business.

ESG has been a topic of deep discussion in both the insurance and investment industry and, in this article, we will address some of the common questions we see when discussing and applying ESG investment principles in the captive industry.

What is the definition of an ESG investment strategy?

This is a question with no clear answer. There are numerous circulating definitions of what ESG means from an investment perspective and there are also a host of synonyms, often used interchangeably (i.e. impact investment, sustainable investing). In general, an ESG investment strategy adopts additional investment objectives and/or direct or indirect positive outcomes over and above pure investment returns.

These outcomes may be clearly defined and quantifiable, for example by targeting net zero emissions, or alternatively be broader targets that are difficult to quantify. Rather than getting bogged down in the plethora of ESG definitions, it may be more helpful for captives to think about ESG in terms of their business objectives and wider operating environment. That is, investment strategies that aim to directly or indirectly produce positive outcomes for a captive’s target market, industry, parent company or immediate environment while also generating a positive investment return.

As an (artificially) simple example, a captive underwriting health insurance may want to allocate some of their investment portfolio to companies who are at the forefront of new healthcare technologies (i.e. biotech) and/or avoid investments that negatively impact on health (e.g. tobacco companies) – perhaps even in time reducing claims for the captive.

How does an ESG strategy practically differ from a traditional investment strategy?

There is a misconception that ESG strategies are radically different to traditional or non-ESG strategies and should be viewed as a distinct investment ‘product’. However, at London & Capital we think ESG is simply an extension of a traditional investment strategy that allows for more data points and enables strategies to be more rigorously adapted for individual client needs.

The starkest difference between the two approaches becomes clearer by looking at the way we would identify potential investments and monitor risk. ESG strategies are often driven by data that falls outside of the scope of traditional investment measures. That leads to a different way of identifying potential investments and managing portfolio risk. For example, we might be analysing new categories of data related to the ESG issues of most importance to our clients (i.e. carbon footprint, equality & diversity measures etc.) before making an investment but we’re also overlaying this data onto a captive’s business objectives to identify the suitability of investments for an individual client. This process is integrated into our traditional investment analysis and done in such a way that we’re able to build investment portfolios that are not only robust from a risk-weighted return perspective but also reflect the underlying ethos and aims of the captive.

Given the apparent trajectory of our society at large and the many issues directly related to ESG that we are grappling with (for example, global warming, social justice, the ability for social media to magnify governance failings etc.), ignoring ESG risk in any investment portfolio, be it in an ESG strategy or traditional portfolio, is likely to result in missing out on future drivers of investment return at best or accepting negative investment outcomes at worst.

However, ESG shouldn’t be seen as a box-ticking exercise. Buying access to an oven-ready ESG strategy through a fund or ETF makes little sense for a captive and is likely to confuse priorities rather than clarify them. Is a fund manager really likely to share the same ESG priorities as your captive, especially given the space is so broad? Can the strategy genuinely be adapted to factor in your existing risk profile, underwriting liabilities or parent company objectives?

How can a captive move to a more ESG aware investment strategy?

A good place to start for a captive is looking again at their business from an ESG perspective. What kind of ESG risks and opportunities is your captive exposed to? Do correlations exist between the risks and opportunities of your liabilities and assets? Can your captive reduce ESG risk or enhance opportunities by making certain investment decisions?

We work in partnership with our clients to answer these kinds of questions but once discussing these issues, your captive can work with an asset manager to identify ESG investment strategies structured to take advantage of your specific opportunity set and/or reduce the ESG risks impacting your business today.

To make it a little more tangible, for a captive underwriting D&O, you might want to identify companies that would also be negatively impacted by the same controversies or issues as your parent company. Perhaps these are industry peers, but they could also be similar sized firms across the globe, key stakeholders in your supply chain or even common shareholders.

The captive can then work with its asset manager to draw up investment guidelines preventing or limiting investments in these companies and agree how this risk will be monitored over time. For a captive where access to capital in the event of a large claim may be limited, proactively managing correlations between potential claims and the performance of your investments can be essential to long-term survival.

When captives approach ESG from a practitioners’ perspective, the topic becomes less daunting, hugely relevant and outcomes much more rewarding for the captive. Can and should captives align their ESG investment strategies with the parent company’s wider objectives?

For captives, their parent company’s wider objectives may naturally have an impact on their ESG investment strategy.

Some parent companies, or even more simply shareholders, will have their own strong views on ESG and it would likely be beneficial for captives to support that through their investment activity in some form or other. That said, this issue really goes back to understanding what ESG means for the captive, making any strategy relevant for the captive and not just a boxticking exercise.

By understanding the risks a parent company is exposed to or the opportunities a parent company is pursuing in terms of ESG, captives can reflect these objectives in their own investment guidelines. That doesn’t necessarily require a parent company to explicitly define their ESG objectives, rather it needs the captive to understand the parent company’s business and how the captive can reduce its own exposure to negative outcomes by investing in an informed way. This has the benefit of positively aligning objectives but also protects the captive in the long-run.

A parting shot…

ESG is increasingly becoming a topic of wide discussion in the captive space but can often be debated in isolation and seen as a ‘hygiene factor’. We would encourage captives to approach it not purely as an investment topic but think about ESG as a wider risk management and future-proofing tool. Ensuring your approach to ESG is relevant and tailored to your captive’s business is more likely to result in real, tangible positive outcomes.

If you’d like to discuss putting together an ESG strategy for your captive, please get in contact at insurance@londonandcapital.com