Unique features of ILS foster inherent ESG qualities: Synpulse’s Roder

As sustainable investing continues to gain traction across the financial world, the inherent ESG qualities of insurance-linked securities (ILS) provides a unique opportunity for investors, according to Patrick Roder, Associate Partner, ILS Practice Lead, Synpulse.

“Sustainable investing (SI) is defined as integrating non-financial factors, such as ESG criteria, into the investment process based on ethical values,” explained Roder.

Globally, both institutions and investors from across the financial universe have shown a growing interest for environmental, social and governance (ESG) qualities. In the ILS asset class specifically, the ESG proposition has become a hot topic across the industry in recent times.

Against this backdrop, Synpulse’s Roder offered some thoughts on the charm and challenge of sustainable investing for the ILS market, exploring what this means for the sector and how an ILS investment can be made in line with ESG considerations.

“ILS is unique in that it introduces investment opportunities in which the underlying assets have inherent ESG qualities,” he explained. “The disaster relief capital provided by the ILS industry increases resilience and amounts to direct and indirect support for multiple UN Sustainable Development Goals. It’s not surprising that ILS players are interested in understanding how to incorporate SI as part of their value proposition.”

In order to develop effective and desired SI capabilities, continued Roder, ILS players should adopt a holistic approach comprised of four components.

“First you create a foundation for the SI framework in the form of an SI strategy on the basis of which you determine the relevant culture, principles, governance, and compliance rules. Then, this foundation allows you to define ESG products and assess the operational ESG footprint. Thirdly, on this basis, you then have to define ESG data integration and analysis, technology management, and the target operating model. Finally, you should define reporting capabilities, align internal and external communications, and train all the relevant personnel,” explained Roder.

To successfully incorporate ESG into the investment process of an ILS fund takes time along the entire risk transfer chain. As a result, policyholders, intermediates, service providers, collateral investments, fund structures, fund managers, as well as the use of freed-up capital should be assessed to understand how they align with ESG criteria, noted Roder.

“We currently see four ways for an ILS fund to make sure an investment fulfils recognized ESG criteria (the extent to which they are adopted depends on the fund’s own SI strategy and the ILS instrument): 1) The ILS investment receives a third-party accreditation, for instance the upcoming EU Green Bond Standard. 2) The cedant or sponsor uses an existing or proprietary ESG approach without external verification. 3) Contractual language excludes certain risks from being ceded or defines the use of ILS proceeds. 4) Sponsors, cedants, or other sources, such as brokers or third-party data providers, create transparency on the ESG characteristics of underlying risks and operations of the cedants through the disclosure of relevant information. While the latter two ways describe current practice, the former two are yet to mature.

“Whatever the motivation for introducing an SI strategy, its implementation should always follow a structured approach to drive a sustainable future for business,” said Roder.