Insurance companies often face several obstacles in implementing net zero emission targets in their investment portfolios. We talk to abrdn’s Xiong Jian about what these are and why they are different from the net zero issues that other institutional investors grapple with.
Like many institutional investors around the world, insurance companies in the Asia-Pacific region are keeping a close eye on governments and boards committing to net zero emission targets, and are looking for ways to implement these targets into their investment portfolios.
But often these insurance companies struggle to figure out how to start, or they don’t have confidence in delivering the required net zero result, Xiong Jian, Senior Insurance Solutions Director, APAC at abrdn , says.
Usually, this is due to a lack of relevant data, knowledge, or investment capabilities within the organisation, and as a result, many insurers still rely on external asset managers to manage environmental, social and governance (ESG) issues and sustainability investments.
“When addressing net zero targets, investors face a number of questions from management. One question is: what does net zero mean? This question is actually not difficult. You can easily find the metrics people use to assess the carbon emissions for your investment portfolio,” Jian says in an interview with [i3] Insights.
“Question number two is: what is my current carbon emission status? This question is a little bit tricky, because it depends on what kind of asset mixture you have in your portfolio and you should be mindful of potential data coverage issues, especially in private markets.
Is my portfolio able to achieve the net zero target? In other words, are you able to project the carbon emission trajectory matrix for your investment portfolio for the next 28 years? This is the most difficult [question]
“So now you have your end point, the net zero target, and you have your starting point, which is the current carbon metrics. Question number three then is: is my portfolio able to achieve the net zero target? In other words, are you able to project the carbon emission trajectory matrix for your investment portfolio for the next 28 years? This is the most difficult one,” he says.
Not only do insurance investors need to assess how to transition the portfolio to net zero, but they also need to do this without compromising their risk and return objectives.
“Let’s say that you’ve already decided to change the current investment portfolio to a net zero portfolio, then what would be the impact on the risk return profile? To answer this question, you really need a whole other framework to figure this out,” Jian says.
“For example, if you are looking at a company in your portfolio, let’s say Google, then you need to understand the carbon situation at Google. You need to figure out the current carbon emissions, but also how the different government policies, technologies and the climate change risks that will affect Google.
“Then you need to work out if Google is able to cope with all of these impacts. Does Google need to buy carbon credits? Will Google suffer or benefit from the customer demand change? Is Google exposed to any significant or minor climate change risks?
“Only after you understand all of these factors you might be able to figure out what the financial impact may be,” he says.
Not only do insurers need to make these assessments at a company level, but they also need to add up all of these risks at an asset class level and finally the overall portfolio level. Yet, insurers in the Asia-Pacific region often lack the data and expertise to put such a framework in place.
“In order to understand and answer these questions, you need to think thoroughly about [your investments] and that is why I think net zero investing is quite challenging [for insurers],” Jian says.
Jian on Investing in Context
Prior to joining abrdn in January 2022, Jian worked for China Life Insurance Singapore, where he was Head of Investment. He feels many asset managers are not always fully aware of the multifaceted nature of investing within the context of an insurance company. It isn’t simply about the highest risk-adjusted returns.
“Insurance investment is more than just investment,” Jian says. “In addition to the factors that you need to consider in a traditional investment process, an insurance company needs to assess many more elements, including asset liability management, capital risk charges and accounting classifications.
“Often, insurers not only target a certain return, but for example they also want to optimise the portfolio for the capital risk charge, or set up a portfolio that fulfills the SPPI (solely payments of principal and interest) requirement under IFRS 9.
“You need both the people that understand the insurance sector and have the infrastructure to run optimisations and modeling [for the capital risk charge],” he says.
Most managers haven’t fully understood the unique needs of insurance companies. I really see a large gap between the sophisticated needs of insurance companies and the deliverables of asset managers
For example, when the new risk-based capital regime came into force in Singapore in March 2020, some insurers were faced with overhauling a significant part of the company’s investment portfolio to meet the new capital requirements. In some cases, 50 per cent of the portfolio needed adjustment to reach the new solvency target.
The changes didn’t mean just switching to more conservative assets, but also affected how certain fixed income securities were treated under the new regime.
Jian gives an example where under the old risk-based capital framework the interest rate risk charge for a callable bond was calculated on the basis of the first call date as the maturity date.
But under the new regime, insurers need to use the final maturity date to work out the duration.
“You can’t use the first call date, so naturally when you calculate the duration for those types of bonds the duration becomes very long and the interest risk charge becomes much higher,” he says.
It is these types of subtleties that often get overlooked when dealing with managers that don’t understand the context insurers operate in.
“Most managers haven’t fully understood the unique needs of insurance companies. I really see a large gap between the sophisticated needs of insurance companies and the deliverables of asset managers,” he says.
This article is sponsored by abrdn. As such, the sponsor may suggest topics for consideration, but the Investment Innovation Institute [i3] will have final control over the content.
[i3] Insights is the official educational bulletin of the Investment Innovation Institute [i3]. It covers major trends and innovations in institutional investing, providing independent and thought-provoking content about pension funds, insurance companies and sovereign wealth funds across the globe.