At Entropics, the most important metric for responsible investment is the ultimate purpose of the insurance contract covered by a cat bond. It is an overlooked metric when studying responsible insurance operations.
The common approach to responsible investing is to use ESG (environmental, social and governance) data to study the investment object. The rationale is clear: It is understandable and applicable to a wide range of industries. Furthermore, the financial logic is that these metrics represent investment or return risks that are not fully captured by traditional indicators.
But when investing in cat bonds, these metrics tend to be less valuable, due to the structure of the deals. Even if we apply the fixed income recommendations by UN PRI to study the entity behind an SPV (the “sponsor” in cat bond terminology), findings are often not particularly informational, as we mostly find large insurers with a good reputation and commonly a very serious approach towards corporate responsibility. The financial ESG risks are all but negligible.
Why, then, should we even care about responsible investments in our operations? A good answer was actually given recently by the French insurer Axa, which declared it would cease to offer investment and insurance support to companies most exposed to coal-related activities. While the decision reduces some business risks, the company also argued that the move is consistent with company’s position on climate change and its broader CSR policy.
The move was immediately followed by calls from a coalition of green groups urging other insurers to stop giving support to coal intensive companies. The spokesperson accused insurance companies of being “laggards on climate action” and thus to contribute to climate change by supporting the coal industry through insurance.
This largely describes Entropics’ approach to responsible investments as well. While we face minor financial ESG risks, the risk we describe as “reputation risk” is vastly larger. If our investors, most of which pursue responsible investments as well, faced losses to fossil energy production or other ethically questionable purposes, we could easily face an investor flight after an insurance loss.
So, while we do traditional ESG research on cat bond sponsors before investing, the most important research is finding out the ultimate insurance purpose is. Perhaps that is an approach that would benefit others researching the insurance industry as well.