The Age of Change? Big pictures, important details and finding returns
The Geneva Association’s 2022 Chief Investment Officer (CIO) Conference, hosted by Sun Life in Toronto, considered key issues for insurers in today’s changing world. It brought together CIOs from across our community along with leading thinkers and experts to debate everything from big picture dynamics such as geopolitics and net zero, through to the real world challenges emerging for the insurance portfolio. After three years in the virtual wilderness, it was a welcome return for the community to reconnect physically.
Keynote speech: Transitioning the Financial System to Net Zero by 2050
Mark Carney, UN Special Envoy for Climate Action and Finance, and Co-Chair of the Glasgow Financial Alliance for Net Zero (GFANZ).
The levels of investment required to get us to net-zero carbon emissions by 2050 are staggering and will require a strong degree of global coordination – not so straightforward given the geopolitics of today. This will cast a long-term shadow over insurance portfolios for decades to come, creating both opportunities for exciting new investments as well as challenges as we seek to adapt what we have.
In his keynote speech, Mark Carney shared his thoughts on how we convert net-zero ambitions into tangible action.
Investing in industries that are already aligned with the net-zero pathway will not be enough. High-emission sectors, such as energy, utilities, transportation and agriculture, will need to phase out assets in a responsible, managed way and evolve in this new world with minimal disruption.
Data is another key issue, with the current quality patchy and complicated by issues of self-reporting. Importantly, international convergence around standards is emerging, with GFANZ in particular being active in developing an open-source data platform, which should be up and running in 2023.
Challenges remain, however. Rising and volatile energy prices are a double-edged sword: though they emphasise the importance of renewables for energy security, in the short term many are turning back to fossil fuels to manage immediate needs. For insurers, the debate is also intrinsically linked to regulation and solvency. Meeting clean-energy targets would require an additional USD 2 trillion in investment globally, for example. Although this presents opportunities, much is also greenfield investment, which comes with construction risk. A mature, more permissive prudential approach that allows insurers to develop the necessary expertise to manage these risks is needed. Alongside, policymakers need to consider ways of mitigating the challenges, such as standardised approaches to power purchase agreements, consistent direction on climate policy and investigating de-risking strategies such as blended finance.
Back to the 70s? The return of geopolitics, inflation and volatility
Frank Kelly, Founder and Managing Partner, Fulcrum Macro Advisors; Randy Brown, CIO, Sun Life.
Geopolitics is very much on the radar of investors today and is critical to any prudent assessment of the insurance portfolio. The hangover of COVID-19 has led to significant demographic and societal change, including dramatic shifts in societal tensions. China’s zero-COVID policy, for example, is now spurring mass protests.
The Russian invasion of Ukraine has also changed geopolitical dynamics dramatically. Power has shifted from Russia to China, with the latter emerging as the dominant partner, along with changes in supply chains, as people look to secure critical supplies such as food, fertilizers and commodities.
The open question is what will happen next. The war seems to have settled into a grinding phase, perhaps over a timeframe of years now, not months. The chances of nuclear war are less than feared given the clear messages from allies such as China to Russia. More concerning will be if the conflict evolves to asymmetric warfare with the targeting of strategic assets such as undersea communications and the rationing of critical supplies such as fertilisers. That would have significant knock-on effects for global food chains, inflation and new waves of migration.
ESG also has gone mainstream and is becoming an emotive partisan topic, with political battlelines being drawn up in the U.S. and businesses and investors caught in the crossfire.
Integrating Climate Risk in the Real World: The net-zero transition, climate litigation and investing in technology
Maryam Golnaraghi, Director Climate Change and Environment, The Geneva Association; Nigel Brook, Partner, Clyde & Co.
How can insurers account for climate change-related financial risks across the balance sheet? A holistic approach that eschews internal silos is critical to inform and underpin decisions. There are also challenges, such as new rules around sustainable finance and taxonomy regulations that are not always aligned, rating agency requirements and shareholder activism.
Net-zero targets are another complication. Though science-based, there is a natural disconnect with economics. As a result, companies may not be able to meet their targets, particularly in the current economic backdrop, raising risks of greenwashing and potential litigation. Having a clear and adaptive framework will be important to deliver a coherent business strategy that targets genuine change.
Climate litigation can also hit corporations, governments and even insurers. This is a fast-growing area, especially in the U.S. and Europe. While the most significant pool of risk for insurers is on the underwriting side, there are problems lurking on the investment side, too. Several municipalities and states have launched actions over losses due to climate change, while courts have been ordering governments to accelerate moves towards net zero, with recent prominent cases in the Netherlands and Germany.
Greenwashing is also attracting attention, both through litigation and more aggressive policing by regulators. For insurers, net-zero targets potentially open up risk too, making it important to think carefully about substance and deliverability.
The ambitious targets set by policymakers require significant investment and, most importantly, substantial scaling up of industrial decarbonisation and new technologies. The insurance industry has a clear role to play here as these reach commercial viability.
Through the Cycle: The nuts and bolts of credit workouts
Lesli Barbi, CIO, Reinsurance Group of America; Olga Kosters, Managing Director, Apollo Global Management; Renee Dailey, Partner, Akin Gump.
Fixed income is core to the insurance portfolio, and its mantra has always been to try and build portfolios that can weather cycles and provide dependable returns. It has been a long time since markets went through a downturn in the credit cycle, and this may be the time to gird up.
For companies, increases in the cost of funding, sustained inflation in input costs and wages, supply disruptions, energy rises and weakening economic growth all increase the likelihood of a recession, strained balance sheets, rating downgrades and defaults. Alongside, as insurers have waded deeper into private debt, there are new complexities to manage and the need for a more hands-on approach to resolve any emerging issues.
For insurers, resourcing for this potential downturn will be key. Workouts of distressed positions are time-consuming, requiring dedicated resources and decidedly more work than when they were performing well. There will likely be multiple creditors and stakeholders to manage and negotiate with. There may be weaknesses in documentation that emerge only as the tide recedes, and complexities within structures to unravel as well. Past that, significant decisions may need to be made quickly, creating challenges for organisational governance structures.
Private assets often allow a greater degree of control and proactive management, with fewer creditors to corral and manage. Companies can be turned around and restructured. Losses can be mitigated and recoveries substantially higher. Resourcing and planning will be key, even if we hope that situation doesn’t materialise.
Finding Opportunities Down the Capital Stack: Is it time for insurers to think about more equity-like strategies?
Steven Goulart, CIO, MetLife; Trevor Kreel, Senior VP and Global Head of Portfolio Management, Manulife; James Mitchell, Head of External Manager Oversight, Phoenix Group.
In 2020, the consensus was that insurers needed to do more in private assets, with some suggesting that they needed to look more at equity, notwithstanding regulatory hurdles.
Two years on, the picture has changed dramatically, but the consensus perhaps less so. Insurers have learnt a lot about private markets and interest in equity-like investments has continued to grow as insurers begin to appreciate their long-term horizon and have significant capital to deploy. Additionally, many areas of interest, such as net-zero-linked infrastructure, have higher levels of risk and involve earlier-stage projects that come closer in substance to equity, irrespective of the intricacies of structure.
For most insurers, there is a barbell approach at work. Lower-rated credit, such as high yield, is a poor fit for liabilities and often punitive from a regulatory capital perspective. Moving into equity-like asset classes, offers higher returns, part compensating for higher capital charges; aligns well with longer-term liabilities and horizons where there are fewer fixed-income assets available; and, in the case of private assets, often has lower volatility. It’s also clear that insurers have no appetite for public equity, given the volatility, except when risks are shared between the insurer and policyholders.
The make-up today is diverse and dependent on individual circumstances, but areas of interest include infrastructure, real estate, private equity, farmland and potentially even venture capital. For insurers in Europe, Solvency II regulation is supportive in areas such as infrastructure equity. The experience for those that have invested has largely been positive and there is a sense that the genie is now out of the bottle, with active programmes and teams in place.