Choosing a sustainable insurer: key considerations and insights

Pension scheme trustees are increasingly looking to risk transfer with an insurer to secure members benefits. We discuss how the management of sustainability related-risks by insurers should be a key aspect of the insurer selection process, and how trustees already have knowledge to help them in this selection process.

From deficit to surplus 

Many trustee boards are experiencing an unexpected shift as their defined benefit (DB) schemes have moved from deficit to surplus. This change, driven by effective management and favourable market conditions, brings new opportunities and challenges.

For trustees who have long focused on reducing deficits whilst protecting members' benefits, securing these benefits with an insurer is now a viable option. However, this phase comes with responsibilities - the crucial task now is selecting an appropriate insurer, a process that must be conducted with the same diligence as previous deficit-reduction efforts. Trustees must continue to prioritise their fiduciary duty, adapting their approach to this evolving landscape whilst still acting in the best interests of scheme members.

Whilst there are many factors to consider when selecting an appropriate insurer, we would argue that the sustainability credentials of the insurer should definitely be one.

Integrating sustainability

Over the last few years, pension scheme trustees have seen increased regulation requiring them to consider Environmental, Social and Governance (ESG) risks within their investment decision making.

On the whole, the industry has responded positively as there is increased recognition that ESG risks should be factored into investment considerations to protect member benefits. This often does not extend to risk transfer exercises, but entering a buy-in is also an investment decision, so why would you disregard ESG risks when selecting your insurer?

In addition, many members now expect ESG to be considered in the decision-making process - there may be reputational risk in not doing so.

A more familiar process than you think

Following this regulatory drive and a greater understanding of ESG’s impact on investments, many trustees expect their investment managers to manage their investments in a sustainable manner.

When you are transacting on a buy-in, this is just another decision on how to invest your assets. A lot of the key assessment criteria you have gotten used to when considering the sustainability credentials of your investment managers still hold for insurers. For example:

• Engagement is still engagement – just like investment managers, insurers will look to engage with the underlying entities they invest with to ensure sustainable long-term value creation. A good insurer, like a good investment manager, will be able to demonstrate their capabilities in this space. 
• Resourcing is still key – to research the very latest thinking on both ESG risks and opportunities, both investment managers and insurers need access to such thinking from an experienced team. 
• Good due diligence still reveals holes – like investment managers, if you start questioning insurers on their approach to incorporating sustainability into investment decision-making and achieving commitments (e.g. net zero targets), you may find some responses lacking the detail you hope for.

Some key differences to be aware of

There are some key differences when considering sustainability in a risk transfer exercise compared to the approach taken by asset managers:

Your investment returns are not directly linked to the sustainability credentials of the portfolio

The bulk annuity is providing cover for the insured members rather than a market return. This means that if the insurer makes poor investment decisions, it’s the insurer’s profitability that is impacted rather than your investment return. Of course, poor investment decisions can still impact the ongoing solvency of an insurer in extreme cases, so it’s still important to understand how good or bad an insurer is at factoring in sustainability issues.

You don’t have the disinvestment lever

With investment managers, in most cases you can threaten disinvestment if processes or performance are not to your liking and improvements are not demonstrated. When you transact with an insurer you lose that ability, meaning you can’t unwind that contract. You need to be sure on the insurer’s credentials before transacting.

The assets may not stay under the control of the chosen insurer

For example, Rothesay recently announced the acquisition of Scottish Widows’ “back book”. Transactions of this nature often lead to a transfer of assets and liabilities from one insurer to another, and so your chosen insurer’s sustainability policies may become irrelevant. Further, funded reinsurance is increasingly popular. Under such an arrangement, the insurer passes both the longevity and asset risk on to a reinsurer either in part or in full. Sustainability credentials are increasingly being considered in the appointment of the reinsurer, but it’s fair to say the reinsurance market is somewhat further behind in their sustainability research, partly because they are often not regulated in the same way as UK pension schemes and insurers. Our due diligence shows that some insurers are increasingly stating their expectations on the integration of sustainability by reinsurers, but further work is needed to improve this aspect of the market.

The typical asset mix might be a little different to what you are used to

Insurers investing to back their annuity book will typically be invested in a mix of bonds and real assets. Engaging with real assets requires a different focus to engaging with bond issuers, so it’s important to understand the insurers’ approaches to engagement in the context of their asset allocation.

Taking the lessons you have learnt from assessing asset managers’ sustainability credentials and applying it to insurers can help you in your due diligence. Just be aware of the different business models.

A simple guide to insurer sustainability ratings

As signatories to the Accounting for Sustainability (A4S) principles charter, at Barnett Waddingham (BW) we expect and encourage ongoing advancements in how insurers incorporate sustainability principles into their operations and decision-making processes.

We can help you navigate the insurer market when considering sustainability credentials by utilising our strong expertise in both the insurance market and the sustainable investment market to bring robust, critical analysis of each insurer’s approach.

To help streamline your review of the insurance market, we have produced sustainability ratings for each of the insurers in the market. Our review considers insurers against their peers as well as against reporting expectations.

Next steps

If you would like to attend a training session on our insurer sustainability ratings approach and critical sustainability issues, please get in touch.