Navigating a potential storm of poor-quality benchmarks that may not align with Insurer expectations

Following an FCA review into ESG benchmarks, the regulator has published a 'Dear CEO' letter which sets out its concerns as to the quality of disclosures provided by benchmark administrators. The FCA noted that these benchmarks are poor, and do not provide sufficient information for users to understand the purpose, or indeed the underlying methodologies. Understandably, the FCA sees ESG benchmarks as integral in ensuring trust in the ESG product market and assisting the transition to net zero.

Insurers are increasingly utilising such benchmarks to implement their own ESG investment strategy, and meet their required sustainability goals, which may include a tilted investment strategy. As such, insurers will want to examine the findings of the review, to ensure that sufficient due diligence has been carried out on the benchmarks on which they rely to support their ESG decision-making processes.

Key takeaways for insurers

1. Weaknesses in an important portfolio management tool
   ESG benchmarks can be a valuable tool to facilitate portfolio management and performance attribution of ESG tilted investment strategies. These benchmarks assist insurers in providing ESG oriented products to consumers, and in providing assurance that their investment strategy is performing appropriately against relevant benchmarks, with similar ESG profiles. Insurers therefore rely on benchmark administrators providing robust and reliable benchmarks, and weaknesses in those benchmarks may affect consumer outcomes.
2. Consumer impact of using weak benchmarks
   Insurers should ensure they understand the benchmarks being used to manage their investments. The gaps highlighted by the FCA illustrate some of the weaknesses in approaches used to derive some ESG benchmarks. What is particularly evident is the subjectivity of ESG factors and how ESG data and ratings are incorporated into benchmark methodologies. Given the range of methodologies, and the inherent subjectivity incorporated in these assessments, building this understanding is key to ensure both that products offered are designed appropriately, and that consumers have sufficient information to understand the products they purchase. Insurers should pay particular attention to these issues considering the new Consumer Duty.
3. Proactive approach to benchmark selection
   Insurers should navigate away from benchmarks with poor disclosures or those that do not align with their expectations. Insurers should regularly review their choice of benchmarks and ensure that those benchmarks remain aligned with consumer expectations where consumers rely on those benchmarks. These reviews should ensure benchmark disclosures are appropriate and where this is not the case, consider whether the use of those benchmarks should be terminated.

Overview of the FCA’s ESG benchmarks review

The key areas summarised by the FCA which we consider relevant for insurers when assessing ESG benchmarks are as follows:

1. contain essential information to enable users to understand what it measures, and its risks, so as to enable informed decision making;
2. ensure that the methodology is easily accessible by users; and

As insurer’s approach implementing their ESG strategies, it’s important to ensure that any benchmarks selected to monitor performance are adequately validated and understood. WTW has supported a range of clients in the insurance industry on this topic, and we would be happy to discuss these issues further, and how WTW can support in addressing them.