Insurance investors that view ESG as a fad, do so at their own peril, says Stephen Acheson, former Global Head of Insurance at Aberdeen Standard Investments.
He explains: "For me the word fad implies something that is going to come and go, and I don’t think ESG is going to go. It is something that is growing, here to stay and something that we are all going to increasingly have to take very seriously."
He argues that the risks posed by ignoring ESG are obvious, real and affect both the assets and the liabilities for firms.
He says: "Research is now is very compelling that ESG factors do affect the outcomes and they can be very influential in adding value to your investment processes, so they must be incorporated into everything that you do.
"ESG is something that is growing, here to stay and something that we are
all going to increasingly have to take very seriously."
"It isn’t just about investment... How you run your business in the face of these real risks affects your competitive position as a firm as to whether you win new business or lose it or make a profit or not.
"It also effects your reputation in the marketplace in terms of whether you are regarded as a leader or a laggard."
He argues that there are three main components of climate change risk; physical, transition and liability.
The physical factor is most important, says Acheson. This is the tangible risks such as losses from floods, fire, storms as well as the costs that climate change is having on the insurance industry. While 2017 was the worst on record for these factors. 2018 was not far behind.
Such catastrophic events hit insurers specifically, but they also impact asset prices in general meaning there is a double-whammy impact.
"ESG effects your reputation in the marketplace in terms of
whether you are regarded as a leader or a laggard"
Acheson explains: "Property valuations fall, credit risk rises, and defaults will happen more frequently. When defaults start happening, there is a consequential risk of covenant risk that happens elsewhere in the business."
He adds that in the longer term, the models that investors use to evaluate these risks are going to have to change - not just to adapt for trends in climate but also in morbidity and mortality. As such, investors will need to take account of rising correlations and the fall in diversification benefits.
The second risk is transition risk which is the cost of moving from where you are now to where you need to be. This isn’t just the cost of moving from one building to another or changing the energy sources you use but also the risk of obsolescence.
Acheson says: "Here I am referring to the products and services that we currently supply and offer which may become unattractive and where the assets of certain companies may become worthless in some areas."
In some cases, he believes the regulators will force this change but in other cases he argues it may just be technological leaps or physical events, or changes in consumer preference.
"Governments and regulators around the world are beginning to enforce
change and those who don’t respond will be left behind."
The last of the three components is liability risk and the risk that poor governance within firms increases the likelihood of negligence claims when things go wrong.
This risk can affect companies directly and the value of their stock prices but indirectly it will also affect the insurers who provided cover.
Acheson concludes: "The reason ESG matters now is that public awareness has risen dramatically. You only need to turn on your TV or read the news to see this.
"Secondly the momentum is growing with governments and regulators around the world and they are beginning to enforce change and those who don’t respond will be left behind."
