Is your buy-in provider investing responsibly? Part 1: Should you care?

Following recent legislative changes, pension scheme trustees have set out definitively their policies on how they allow for environmental, social and governance (ESG) factors in their investment processes and how engagement is undertaken on relevant investment matters.

Many trustees state that they consider these areas when selecting and monitoring their investment managers. But what about the insurers who – for an increasing number of schemes – provide bulk annuity policies, so-called “buy-ins”? A buy-in policy is an asset of the scheme but, in my experience, trustees rarely assess the life insurer’s ESG or engagement practices before contracting with them.

Should trustees consider buy-in providers’ approaches to responsible investment?

We think they should, which is why we conducted our first formal Responsible Investment (RI) survey of buy-in providers in late 2019.

Conducted in a similar fashion to our longstanding RI survey of investment managers, we asked the eight insurers in the bulk annuity market to answer a series of questions about their ESG and engagement activities. Seven of them did so. We analysed their responses and assigned each insurer an overall score on a 1-4 scale where 1 is weak and 4 is strong. These scores are available to our clients to assist in selecting an insurer and for ongoing oversight of how RI is in practice being implemented for their assets.

Why should trustees consider RI for their buy-in policies?

I suspect many trustees assume that RI isn’t relevant for their buy-in policies or, if it is, that they can’t influence it. It is true that insurers’ RI practices are primarily the responsibility of their boards, so I agree that it is more important that trustees consider RI for, say, their actively managed equity funds, but I still think it is good practice for trustees to include buy-in policies in their RI oversight.

One reason for this is stewardship. Trustees have an influential role in the investment chain. They can, and should, use this influence to encourage good practice by all parties involved in looking after their assets. This will help to safeguard the long-term sustainability of the environmental, social and economic systems on which investment markets – and the security of their members’ benefits – ultimately depend.

Another reason is management of financial risks. Unlike for the rest of the scheme’s assets, the performance of the underlying assets does not affect the value of a buy-in policy. However, although the insurer is contracted to provide income to match the benefits insured under a buy-in policy, ultimately, the scheme trustees are responsible for paying those benefits. There are therefore some residual financial risks associated with the contract relating to the failure of the insurer. Trustees can take considerable comfort from the protections afforded by the insurance regulatory regime and Financial Services Compensation Scheme, but there remains a small chance that these protections will fail. This is most likely to happen when there are severe market difficulties affecting several insurers at once. ESG factors (eg climate change) are a potential source of such severe market-wide problems. Hence an insurer who has strong practices for managing ESG risks to its assets and liabilities is more likely to be financially robust over the long-term.

Can trustees influence insurers’ RI practices?

Yes, I believe they can. By telling insurers that they are considering RI during their selection process, and by probing any concerns they identify, trustees will encourage better RI practices. Perhaps in future we will even see trustees insist on RI requirements being included in their buy-in policies.

Trustees have less influence through ongoing monitoring of RI – after all, unlike their other assets, they cannot move their money to a different provider if they are unhappy with the RI approach. Nonetheless, trustees who have completed one buy-in transaction will typically undertake others in future and their existing insurer will no doubt want to win that business too.

What did our survey find?

In Part 2 of this blog we summarise our findings and suggest some next steps for trustees.