Billions of assets purchased by insurers to back UK retirement promises have the potential to drive corporate progress on issues such as climate change, and pension fund trustees are now indicating a willingness to pay extra for better stewardship.
Trustees of defined benefit pension funds are increasingly prepared to pay a premium for insurance products from companies with materially better sustainability practices, according to a new poll, as scrutiny turns to insurers’ vast back books.
DB pensions have become increasingly expensive for companies as returns have dropped and former employees are living longer.
Promises that once seemed affordable are now a source of significant balance sheet risk for employers, and a funding crunch in the past decade contributed to high-profile UK collapses, including that of outsourcer Carillion.
It’s pretty easy to sell exposures to companies and get your headline numbers down, but that doesn’t necessarily change what’s happening on the ground
Marcus Mollan, Aviva Investors
In an effort to reduce this risk, many employers and their scheme trustees have turned to the insurance market, buying “bulk annuity” policies to cover portions of liabilities, known as buy-ins, until they can afford to wind up completely.
In the UK, the bulk annuity market saw £28.6bn of deals last year, with similar totals in the less-developed US market and smaller sums in countries such as Canada and Ireland.
If a pension plan is well funded enough to buy an insurance policy for all of its members, known as a buyout, it can transfer all assets and liabilities to an insurer and cease to exist on the employer’s balance sheet.
But with partial insurance policies known as buy-ins remaining on the balance sheet, trustees are beginning to question the sustainable credentials of the insurers they transact with, who buy baskets of investment-grade fixed income and alternatives to match payouts.
At a recent webinar hosted by UK consultancy Hymans Robertson, 62.1 per cent of attendees surveyed said they would be prepared to pay a larger premium to transact with an insurer that better managed environmental, social and governance concerns.
This is despite bulk annuity policies not being covered by the UK’s requirement for pension funds to disclose emissions under the Task Force on Climate-related Financial Disclosures framework, and the risk of insurers governed by Solvency II not paying out being small.
The results, therefore, suggest that pension funds see this area as a logical extension of their ESG duties, even in the absence of significant financial or regulatory risk.
Of those who said they would pay more for better insurer stewardship, the largest portion of the vote said they would expect a premium of 0.1–0.5 per cent — worth millions on some of the multibillion pound deals signed in recent years.
Opportunity in better disclosures
Paul Hewitson, actuary and risk transfer specialist at Hymans Robertson, says that no insurer in the market is such a laggard that the company would advise trustees not to transact.
Instead, assessment of ESG credentials is driving pricing negotiations, with better performers, particularly on transparency and disclosure, able to expect to be preferred over competitors at the same price point. Hewitson says that factors such as “whether [insurers have] published their TCFD reports yet” will influence trustees.
Insurers, particularly those that operate multiple lines of business beside annuities, told a recent Hymans webinar that getting a clear picture of their Scope 3 emissions is still a work in progress.
Hewitson says: “We’re trying to get more clarity on how the insurers are trying to reach their net zero targets. Some of that detail I think will be very important as more gets published.”
Unsurprisingly, insurers are keen to show clients they have been integrating ESG into decision-making for some time — after all, the physical impacts of climate change are likely to impact insurance directly.
The consultation we’ve seen thus far doesn’t give the impression that the government is quite doing enough to push us to clean up our portfolios as far as the transition to net zero requires
Anisha Gangwani, Legal & General Retirement
But while new assets are seeing thresholds applied to investment in fossil fuel energy sources, for example, vast back books of assets purchased to fund previous policies pose a more complex ESG challenge, albeit one where a desire not to unpick portfolios is forcing engagement to the fore.
“We prefer to do that through engagement with borrower companies rather than just divesting. It’s pretty easy to sell exposures to companies and get your headline numbers down, but that doesn’t necessarily change what’s happening on the ground,” says Marcus Mollan, director of annuity asset origination at Aviva Investors, which has committed to net zero in its portfolio by 2040, with a significant reduction by 2025.
While debt investors do not typically have the same leverage as equity investors when it comes to engagement, they are able to use the growth in sustainability-linked debt to influence corporate behaviour. Aviva is close to reaching its target of £1bn in sustainability-linked bonds in its portfolio, and says it looks to use this to add sustainability criteria to existing loans by refinancing.
On commercial mortgages, for example, Mollan says: “We know that borrowers will come back to require further loans… let’s take both the historic mortgage and the new one and turn that into a sustainability-linked mortgage for the whole.
“[Borrowers] know that the more they’re doing on the ground now, and the more they’re engaging on this topic now, the more attractive they’ll be when it comes to new finance or refinancing existing loans,” he says.
More rigour for UK’s Solvency II spin-off?
Still, with the burden of decarbonisation in particular still falling on private investors, some think policymakers should be doing more to direct the entire insurance market.
How should trustees build sustainability into governance?
Video: Expectations are rising over trustees’ abilities to incorporate sustainability into their scheme governance and journey planning. Cardano client director Helen Prior explains how to articulate sustainability beliefs in polices, how to organise trustee committees, and how to balance risk and reward.
The Bank of England’s Prudential Regulation Authority has recently authored a discussion paper on tweaks to the Solvency II regime imported from Europe, while HM Treasury has suggested freeing up assets to invest in its “levelling up” agenda.
“There’s quite a bit of ‘talking the talk’ of wanting to change Solvency II enough to move capital from insurers into levelling up green infrastructure,” says Anisha Gangwani, head of investment business development at Legal & General Retirement.
“But the consultation we’ve seen thus far doesn’t give the impression that the government is quite doing enough to push us to clean up our portfolios as far as the transition to net zero requires.”
She welcomes the apparent readiness of some trustees to pay more for better ESG products, since pricing in investment-grade green projects has become so tight that insurers might be prompted to leave this space in favour of more “ESG-neutral” corporate bonds if clients cannot share the cost.
This article first appeared on ESG-Specialist.com
