Aon: regulatory clarity required to drive ESG-compliant ILS growth

The Insurance-linked Securities (ILS) sector has “innovated faster” than the wider market but the proliferation of ESG metrics and lack of clarity over regulations is leading to confusion among ILS managers, investors and insurers, Aon’s Paul Schultz and Meredith Jones have warned in a special COP26 edition of Close Quarter.

Schultz, CEO of Aon Securities, stated that less credit has been given to role that ILS can play in meeting the global drive towards net zero, but stressed that the industry as a whole must do more to educate markets and clients on alternative risk transfer products available and how they can work in line with ESG initiatives.

“ESG and ILS are linked at the hip. ILS investors have innovated faster in some regards than the reinsurance industry and really have an opportunity to take a lead and set the tone for how we move forward,” Schultz told The Insurer TV. 

Schultz pointed to the recent genesis of ‘green’ or ESG-focused multi-class asset investment funds that are broadening their mandate to include ILS and catastrophe bonds.

He noted that ILS, catastrophe bonds in particular, have already proven their ESG-relevant features by providing disaster risk financing to support recovery after severe weather events and natural disasters, helping bridge the gap between private capital markets and humanitarian project funding. 

But the executive stressed that the ILS sector – particularly managers and allocators – must work to clarify what the advantages of ESG-compliant transactions are when it comes to pricing and risk and return.

“Is the ESG outcome equal to where the market is today and do the non-ESG compliant transactions somehow get penalised in terms of pricing and capacity? Or is there an economic advantage for an ESG issuance because the investor community wants to support that and is willing to take less of a return on that dollar of risk transferred?

“This clearly has to be articulated for us to understand what the framework is to really drive ESG,” he said.

Schultz added that clarity is also needed as to how a product can be defined as ESG-compliant and a consensus on what information is required by ILS managers: “That’s really a disclosure issue, as well as a scoring issue,” he continued.

“We’re clearly in the early days of collecting the input from the market to understand how they would like to see this get done, and not surprisingly there’s no consensus yet.

“You’re going to see very different questionnaires from one ILS manager than the other, and it’s just really hard to get too much traction. But having said that, we’ve seen some progress on disclosure and now we need some progress on issuance,” he said.

ESG framework overload

Jones, Aon’s global head of ESG, also warned that the proliferation of ESG frameworks and requirements are not only “problematic” but may cause confusion among both firms and their investors. 

She said that there are over 650 different mandatory and voluntary ESG and climate change regulations now in place across the globe.

“If you’re an insurer, or if you’re an investor and you’re trying to pass through all of that different information that may be coming to you, that is not an easy thing, it’s not a desirable thing, and quite frankly, it’s not the best use of anyone’s time,” Jones explained, adding that greater consistency is required between regulatory regimes and ESG frameworks.

“To the extent that we can get robust disclosures that are harmonised across jurisdictions, I actually think that that would be one of the big wins for the regulatory bodies,” she continued.

Jones said one desired outcome from COP26 would be to see “coordination” between the plethora of available metrics and precise guidance on what firms need to be doing.

“Trying to figure out exactly how we’re going to achieve those goals could be a really great outcome; to have some practical suggestions and tips as well as coordination between different regulatory environments and different governments and the way that this information is going to be evaluated and disseminated,” Jones explained.

While governments and regulators will act as an “accelerator” in driving both individuals and businesses towards net zero, it is the (re)insurance sector that is best placed to act as a “facilitator” in the transition to a green economy.

Jones noted that the sector was not really thought of as much of a driver to net zero until recently but said the momentum that insurance can put behind the transition “is really quite incredible”.

“Insurance is going to be a prime driver of this as we begin to learn the linkages between ESG and insured losses. I think more and more insurers are saying: ‘we need to pay attention to ESG’, that’s causing the companies that are coming to them for risk transfer to make those changes too,” she said.

“If the money is asking for this and the risk transfer is asking for this, those are the things that make the global financial ecosystem go around.”