Insurance ESG Considerations:

A Practitioner's Viewpoint

on Portfolio Customization 

 

KEY TAKEAWAYS

  • With regard to ESG, insurers have a distinct challenge. ESG factors can influence both assets and liabilities. 

  • Our goal in managing insurance assets is to create balanced and resilient portfolios that can evolve in terms of construction and risk management. 

  • Our insurance solutions team creates custom portfolios based on a data-driven, research-informed approach. This includes proprietary ESG ratings and technology support, engagement, screens and custom client reporting. 

 
WRITTEN BY
 
Pramila Agrawal, PHD, CFA
VP, Director of Custom Income Strategies

PramilaAgrawal-2
 
Erik Troutman, CFA, FSA, MAAA
VP, Insurance Strategist

ErikTroutman-1
 
Sean Saia, CFA
VP, Investment Director

SeanSaia
 
Colin Dowdall, CFA
VP, Director of Insurance Solutions

ColinDowdall
 

Environmental, social and governance (ESG) matters have transitioned from an infrequent and standalone set of considerations into numerous pervasive, highly complex issues for corporations, government entities and investors of all sizes. 

The implications of ESG matters are already influencing decisions about investments, consumption, regulation and legislation. We believe the focus on ESG has created interconnectedness across the global economy that will play a major role during the next 20 years.

 

ESG Interconnected

 

Insurers' Complex ESG Profiles  

Insurers are in a unique position as they carefully evaluate the impact and interrelation of ESG influences on their balance sheets—both asset and liability sides.

Consider the challenges different types of insurers face. Property and casualty (P&C) insurers experience increases in loss frequency and severe shifts in climate and weather events in geographies where they have placed investment dollars. Health insurers contend with societal pressures that increase demands for equitable coverage at cost levels that are more accessible to the broader population. Health insurers are also encouraged to invest in their coverage areas to deliver these services. Life insurers price their long-tail liabilities that could have altered experience outcomes based on shifts in climate patterns and emergence of new diseases. This may be concurrent with losses on their investment portfolios that are highly exposed to the very same ESG factors. In addition, insurers express a commitment to enhancing equity and diversity, and influencing long-term health and economic growth.

Insurance company boards of directors are tasked with navigating this multi-faceted ESG environment at the enterprise risk level while continuing to provide profitable products and investments that generate sufficient income or return levels. Insurance portfolios have long been customized, and the need for tailored portfolios is only increasing as insurers look to their portfolios to provide the greatest potential for meeting their income goals while delivering on new and shifting ESG demands. We believe that each insurer is on its own distinct ESG journey, and Loomis Sayles can play an important role in this journey.

 

Need for Customization 

In our view, customized portfolios provide the greatest potential for meeting insurers’ income goals—especially in the ESG space.

As awareness of ESG matters has grown, investors have become more attuned to their complexity, the inherent ESG ratings dispersions among issuers, and the likely benefits of taking a focused, customized approach. To address these dynamics effectively, it is essential to understand the potential impact of material ESG factors on investment performance.

Insurers looking for ESG solutions typically approach Loomis Sayles in two ways. Some define their specific ESG expectations, while others seek our input to help identify and evaluate the material ESG factors to include in their investment solutions. In either instance, we can help our clients understand the potential portfolio impacts of their decisions. Our credit analysts’ ESG ratings, supported by Loomis Sayles’ proprietary ESG tools, enable us to create custom portfolios that move clients closer to their ESG goals.

In terms of scope, insurance investors can realistically take a holistic approach that addresses a spectrum of ESG issues to improve a portfolio’s ESG footprint. However, we recognize that some insurers may target a specific area of ESG challenges, including affordable housing, education, social equity, gender equality and clean energy, to name a few. Our proprietary portfolio construction platform allows us to target a wide array of ESG factors and consider risk-return tradeoffs when building portfolios.

 

Do Investors Have to Sacrifice Alpha Opportunities?  

There is a common misconception that investing in issues with high ESG scores involves sacrificing alpha. We would argue that while some sectors or companies screened out by ESG indicators may seem to offer relative upside, they may also carry higher long-term risk from ESG factors (e.g., litigation risks related to environmental harm, labor retention issues or impact of irresponsible suppliers). 

 

Tools for a Thorough and Thoughtful Appraisal: In-House Programs, Screens and Engagement   

We maintain a comprehensive basket of tools and analytics to support Loomis Sayles’ ESG investing. These tools vary from custom programs built in-house, such as the Unified Relative Value tool (described below), to screens based on third-party data (e.g., negative and positive screens). Each tool can have a role in helping insurance portfolios move closer to their ESG investing goals.

 

PROPRIETARY ESG TOOLBOX

To assess the most likely outcome, our credit research analysts carefully construct “materiality maps” for their coverage sectors. These tools focus on the ESG factors and sub-factors with the greatest potential to impact an industry, including adjusted weightings for specific ESG factors to reflect their relative importance. In the end, our credit research analysts evaluate each issuer they follow against its industry's materiality map and assign a Loomis Sayles ESG score of 1 (above industry average) to 3 (below industry average), as shown in the sample map.

 

Metals and Mining Ex

 

LOOMIS SAYLES' UNIFIED RELATIVE VALUE TOOL 

Using Loomis Sayles’ proprietary relative value tools, we can analyze alpha opportunities through an ESG lens. As shown in the following chart, our relative value tool highlights rich/cheap names within a given industry based on constant-duration market spreads and ratings-based fair value. Issuer ESG score (1, 2, or 3) along with specific analyst-driven ESG engagement notes (see Appendix A) are integrated within this tool for all issuers. As a result, we are able to filter preferred names that, in our assessment, add an absolute and relative ESG advantage. For instance, issuer A in the chart looks cheap relative to its industry peers given its rating and duration, and it also enjoys an ESG score of “1” from the sector analyst. Our goal would be to overweight such names in a portfolio. 

 

Relative Value Tool

LOOMIS SAYLES' ESG CENTER 

We have developed an internal technology application, the ESG Center, as a central location for external and internal ESG data. This includes internal fixed income ESG scores and climate footprint analysis for all fixed income portfolios. Our portfolio managers can use the ESG Center to assess ESG metrics within their portfolios and relative to their respective benchmarks.

 

ESG Scoring

 

CUSTOM SCREENS BASED ON THIRD-PARTY DATA  

“Negative Screens” (exclusion screens) have been used for decades for socially responsible investing and can be applied to any investment universe. Screening criteria can include sector (e.g., alcohol, tobacco, gaming, nuclear weapons) and company-specific metrics (e.g., carbon intensity, geography of operation, labor safety).

Some insurance clients have specific restricted lists that take into account existing underwriting exposure. For example, sector-level exclusions for tobacco and weapons-related industries are often implemented in our portfolios. Such exclusion screens can be easily defined and implemented. In addition, screens leave less up to interpretation and can be accurately coded. The screening criteria tend to remain constant over time and typically do not need frequent updates. Also, screens can have an immediate cumulative impact of penalizing ESG offenders by non-extension of capital.

We recognize that negative screens are binary and cannot identify companies with positive momentum in improving their ESG footprints. Beyond the restricted lists of our insurance clients, we are careful not to use comprehensive negative screens that can lead to large-scale sector exclusions, which can reduce portfolio diversification and omit issuers with improving ESG metrics.

Loomis Sayles has deep experience in implementing negative screens. We currently subscribe to a wide array of ESG data and research providers, including MSCI, Sustainalytics, Truvalue Labs, ISS Climate Impact Reporting Solution and the SASB (now known as the Value Reporting Foundation) Framework. From these resources, our system can pull in data points for more than 75 socially responsible investing and ESG factors. We continually evaluate our resources and the need to supplement them with additional data and the development of technological tools.

“Positive Screens” can identify companies that are either industry leaders in incorporating ESG factors in their businesses, or are pioneering innovative solutions to address and alleviate specific ESG risks.

Positive screens seek to reward and empower ESG leaders. For instance, we could seek issuers that have the lowest carbon intensity within their sectors. These screens can point to potential role models for peers and investors. Given that companies with relatively high ESG scores tend to outperform peers over the long term, positive screens may also give an opportunity to tilt a portfolio toward potential winners.1

We recognize that positive screens need clear goal specification and require greater involvement from asset managers to identify industry leaders and positive-momentum names. A deeper dive into the subcomponents of ESG is required to identify improvement along these dimensions. For instance, if an energy name in the exploration subsector receives a high “E” score, a deeper dive can reveal if the driver is its prudent use of water or management of oil spills. These scores may need frequent updates as definitions of industry leaders and assessment criteria change.

Loomis Sayles has adopted a wide and deep approach to ESG scoring that is instrumental in establishing and implementing positive screens. Aside from comprehensive third-party data, Loomis Sayles’ credit research analysts rate a large number of credits across ESG factors. This rating methodology incorporates critical data from our materiality maps. Loomis Sayles’ credit research analysts are committed to evaluating companies across a variety of ESG sub-factors and identifying industry leaders and ESG pioneers.

For example, a midstream natural gas pipeline company consistently demonstrated commitment and action toward improving its environmental and social impact. Even though the energy sector has a poor overall E score, our credit research analyst noted that this company was taking significant steps toward recycling water use, reducing carbon emissions and decreasing methane intensity. The analyst’s assessment of the company’s environmental efforts is reflected in the sector-adjusted ESG score. This allows the company to be highlighted in a positive ESG screen that is designed to select ESG industry leaders.

 

ACTIVE ENGAGEMENT   

“Engagement” refers to investors actively engaging with companies to understand and influence their ESG policies and efforts. The process can involve positive, influential communication between investors and companies leading to sustainable, positive changes. It can encourage companies to innovate within their sectors and allows them time and capital as they transition to better ESG practices through modified long-term capital expenditure plans. This also gives investors an opportunity to invest early in companies that have higher likelihoods of greater future returns as they improve their abilities to mitigate ESG risks.

As an example, our chemical sector credit research analyst engaged with the management of a Latin American chemical company regarding ESG topics. Later, the company published 12 large commitments to ESG as well as a new ESG page on its website. Due to our dialogues and efforts, we would classify this as an engagement outcome. The company announced plans to increase its PET (polyethylene terephthalate, a form of polyester) bottle recycling capacity, leverage its partnerships to develop chemical recycling, develop biodegradable alternatives for the food and beverage market, and work on making chemical recycling viable. The company also announced several other measures for enhancing diversity, equity and inclusion, as well as community engagement and product improvement.

Another example involves a top-tier communications company that ESG data providers rated poor. A Loomis Sayles credit research analyst engaged with the head of the company’s investment relations to learn more about the company’s efforts to promote gender and racial equality, workforce training and compensation and achieving connected communities. After this deep dive, our analyst adjusted her underlying E, S and G scores and overall ESG score, which deviated from other third-party ESG ratings. A strong ESG rating automatically elevated this name in our security selection process where its positive ESG score along with its attractive relative value made it a top choice. Such one-on-one engagement with the company’s senior management allowed us to better capture likely future credit improvement on improving ESG factors.

We recognize that engagement requires sustained commitment by investors. It requires persistent follow-ups, evaluations of changes implemented and continuous dialogue on innovative thinking. In comparison to negative and positive screens that are data-driven and easier to implement, it is harder to track engagement and implement portfolio construction based on it.

Loomis Sayles has a proprietary ESG engagement database across asset classes. This database was launched in 2016 and captures detailed analyst comments from conversations with companies regarding specific E, S and G topics. The analyst records each engagement in addition to providing other credit comments, spread movements, headline news, relative value changes, earnings reports and rating upgrades and downgrades. This gives valuable insights into a company’s ESG momentum and informs the investment team’s decision to add or remove a name from the portfolio.

 

PORTFOLIO CONSTRUCTION: ESG SENSITIVITIES AND INSURERS’ INVESTMENT GOALS  

Integrating our ESG philosophy and preferences into our investment management requires a nuanced approach that impacts all stages of our investment process—portfolio design, portfolio construction, security selection, execution and day-to-day portfolio management.

 

CLIENT PREFERENCES AND GUIDELINES

In the design stage, we work closely with our clients to determine their ESG preferences and guidelines. A client’s explicit restricted list is an example of a negative screen. As discussed earlier, negative screens can prohibit sectors, issuers, countries or add hurdles for issuers to meet to be allowed in the portfolio. Another negative screen example can be excluding utilities where more than 75% of their power generation is based on fossil fuels. We can also screen out sectors or issuers that the investment team deems to have adverse risk and return characteristics based on poor ESG characteristics. These screens narrow down the starting universe of securities for portfolio construction.

Once excluded, these securities are never considered at any stage of investment until the universe is re-estimated. Depending upon the client guidelines and instructions, these screens can be broad-based or focused on a few specific factors. For instance, we can have a narrower focus on carbon emissions or gender equality.

 

PORTFOLIO OBJECTIVES AND ESG CONSIDERATIONS

Our portfolio construction objective is to create a diversified portfolio with the highest potential risk-adjusted return. For a yield-focused mandate, the goal would be to maximize risk-adjusted yield and, for an income-oriented mandate, the aim would be to maximize risk-adjusted income. We can enhance the ESG characteristics of a portfolio while balancing risk and return objectives in a variety of ways:

  • Negative screens eliminate the names, sectors, countries that we have the most sensitivity to. Depending upon the type and extent of these eliminations, they may have a low or significant impact on diversification and return potential.
  • Well-constructed constraints or limits are powerful ways to express ESG preferences in a portfolio. For instance, restricting energy, chemicals and mining-related sectors to 10% can still allow a less-preferred sector in the portfolio but limits such exposure. Similar constraints can be added at country or geopolitical levels.
  • Another way to tilt a portfolio toward “better” ESG names is to allow higher weightings in top-decile ESG names and lower weightings in bottom-decile ESG names. Top-decile ESG bonds may be defined as industry leaders in adopting environmentally-friendly policies, meeting ambitious emissions targets, launching pioneering solutions and/or taking distinct measurable steps toward transition.

Setting a minimum market weight in green bonds or sustainability-linked bonds is yet another lever to improve the ESG footprint of a portfolio. Our proprietary ESG scoring system, informed by in-house materiality maps created by Loomis Sayles credit research analysts, allows the investment team to have a granular view of each credit along ESG factors and sub-factors. Our extensively mapped securities database has issuer- and issue-level analytics. These can be targeted at the single instrument level or at the portfolio level during our construction process.

 

YIELD, RETURN AND INCOME IMPACT

A pertinent question is how ESG considerations impact the yield, total return or income of the portfolio. This depends on the extent and depth of exclusions, sector and issuer constraints and overall portfolio targets. For our yield-focused mandates, we have often been successful in improving the ESG footprint of the portfolio with little to no give-up in yield. We believe that issuers and sectors with the most prominent ESG risks, as reflected through our materiality maps, are likely to be volatile and also likely to show lower returns over the long term.

Our goal in managing insurance assets is to create balanced and resilient portfolios that can evolve in terms of construction and risk management. We do this by using a data-driven and research-informed approach, sensitive to the different implications of ESG by region and asset class. Sophisticated tools enable us to monitor valuations and relative value through the intersection of fundamental credit quality and ESG factors. Our clients can benefit from the insightful ESG-related reporting we provide.

 

WHAT’S NEXT – FRAGMENTATION TO UNIFICATION  

As interest in ESG investing has grown, investment managers have entered the market with many ESG-themed/oriented products. However, given the complexity of ESG factors, the difficulties in measurement and the questions of what constitutes a material or immaterial ESG impact, the potential for greenwashing or abuse of ESG factors has risen.

Loomis Sayles believes strongly that the investment industry should strive for a more unified set of high-level definitions and nomenclature with regards to what constitutes ESG factors, impacts and correct metrics. Recent actions by both regional and international regulatory bodies show that they share the view that unification of nomenclature and disclosure are important topics for the future of ESG. However, unification of definitions and nomenclature is not a straightforward task, as the chorus of interested parties is not always aligned. The risks of orphaning needed transitional industries or other unintended ESG consequences are real issues that need consideration. Loomis Sayles actively engages in many industry activities, initiatives and groups to support efforts and discussions in pursuit of a stronger ESG investment industry (see Appendix a, Partnerships).

We understand that ESG is still evolving and growing; regulations and definitions are not fully formed as of yet. Therefore, we support a customized and flexible ESG process with clients, undertake discussions with clients around ESG and their goals and embed flexibility throughout our credit research and portfolio construction processes.

 

Russian Invasion of Ukraine Brings Rapid ESG Implications 

The speed at which economic sanctions, corporate exits and consumer denouncements materialized after Russia’s invasion of Ukraine provided a vivid example of ESG considerations for insurers. Consider the unprecedented galvanization amongst sovereigns, corporations and individuals to condemn the invasion and support Ukraine. This has resulted in wide-scale amendments of policies and investment guidelines as well as far-reaching changes in consumption/investment preferences by organizations and individuals. Insurers across the globe have felt the impact of this crisis on the asset and liability side, some more than others.

 

APPENDIX A: PARTNERSHIPS   

Loomis Sayles is proud to work with global peers on sustainable investing initiatives. We participate in the following industry groups, which typically encourage improved and standardized disclosure of ESG risks and opportunities among corporations, issuers and investment managers.

  • UK Stewardship Code (since 2013), Tier 1 (since 2017, when tiering was instituted), membership reaffirmed in 2021
  • Signatory, United Nations-Supported Principles for Responsible Investment (since 2015)
  • Signatory, LGPS Investment Code of Transparency (since 2018)
  • Member, Association of Institutional Investors, collaborating with other asset management firms to standardize key language and industry processes (since 2010)
  • Member, Sustainable Accounting Standards Board (SASB) Alliance (since 2019)
  • Supporter of the Task Force on Climate-Related Financial Disclosures (since 2020)
  • Member, Transition Pathway Initiative (since 2020)
  • Participant, FCLT Global (Focusing Capital on the Long Term) (since 2019)
  • Signatory, CDP (formerly Carbon Disclosure Project) (since 2020)
  • Signatory and investor participant, Climate Action 100+ (since 2021)

 

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Endnotes

1Uncovering the Relationship by Aggregating Evidence from 1,000 Plus Studies Published Between 2015 – 2020. https://www.stern.nyu.edu/sites/default/files/assets/documents/NYU-RAM_ESG-Paper_2021%20Rev_0.pdf

Disclosure

This paper is provided for informational purposes only and should not be construed as investment advice. Any opinions or forecasts contained herein, reflect the subjective judgments and assumptions of the authors only, and do not necessarily reflect the views of Loomis, Sayles & Company, L.P. Investment recommendations may be inconsistent with these opinions. There is no assurance that developments will transpire as forecasted and actual results will be different. Data and analysis does not represent the actual, or expected future performance of any investment product. Information, including that obtained from outside sources, is believed to be correct, but we cannot guarantee its accuracy. This information is subject to change at any time without notice.

Examples above are provided to illustrate the investment process for the strategy used by Loomis Sayles and should not be considered recommendations for action by investors. They may not be representative of current or future investments and they have not been selected based on performance. Loomis Sayles makes no representation that they have had a positive or negative return during the holding period.

Commodity, interest and derivative trading involves substantial risk of loss. This is not an offer of, or a solicitation of an offer for, any investment strategy or product. Any investment that has the possibility for profits also has the possibility of losses, including the loss of principal.

There is no guarantee that the investment objective will be realized or that the strategy will generate positive or excess return.

Past performance is no guarantee of future results.

LS Loomis | Sayles is a trademark of Loomis, Sayles & Company, L.P. registered in the US Patent and Trademark Office.

MALR029031

WRITTEN BY
 
Pramila Agrawal, PHD, CFA
VP, Director of Custom Income Strategies

PramilaAgrawal-2
 
Erik Troutman, CFA, FSA, MAAA
VP, Insurance Strategist

ErikTroutman-1
 
Sean Saia, CFA
VP, Investment Director

SeanSaia
 
Colin Dowdall, CFA
VP, Director of Insurance Solutions

ColinDowdall