When the term ESG was first used in the 2005 UN Global Compact landmark study Who Cares Wins, few insurers could have envisaged how much weight the acronym would carry nearly 20 years on. Today, with climate risk, social justice and corporate responsibility interlinked at the top of the agenda for financial institutions, there’s no escaping it.
Not only are consumers and investors more discerning than ever when making their purchases and stock picks, regulators and rating agencies are digging ever deeper on ESG.
"Inconsistent ESG data is impacting the insurance industry’s ability to respond to climate risk."
As both risk underwriters and institutional investors, insurers’ ESG performance is coming under closer scrutiny from regulatory bodies at different levels.
For example, every two years the Bank of England puts out a Biennial Exploratory Scenario (BES) involving banks and insurers. For each exercise there is a different focus for the scenario considered that is not covered as part of the annual solvency tests.
Philip Allan, consultant at London-based Oxbow Partners, says scrutiny of climate-related risks especially is growing: “The last Bank of England stress test highlighted that inconsistent ESG data is impacting the insurance industry’s ability to respond to climate risk. Insurers tend to rely on ESG scoring to understand their performance against portfolio transition targets but every respondent had incomplete areas in their submissions due to data availability.”
The BoE is not alone in pushing the ESG risk envelope, however. Nigel Brook, partner at the law firm Clyde & Co, says that ESG will be incorporated into wider corporate sustainability reporting and disclosures, through legal frameworks such as the one introduced by the EU Corporate Sustainability Due Diligence Directive.
“There is an increasing awareness that environmental degradation (under E) caused by corporate activities is often associated with human rights abuses (under S), so merging these two concepts under the same framework is a natural first step,” Brook says.
“We have seen less progress towards comprehensive ESG (including G) reporting and disclosures, although organisations such as the International Sustainability Standards Board are actively looking to put together fully integrated ESG/sustainability reporting. We expect such an ESG standard to be pushed out to the insurance market in the next three to six years,” he adds.
The ratings game
As mentioned, regulators are not the only source of ESG pressure being applied to insurers. In a report at the end of last year, Fitch Ratings said insurers’ underwriting and investment strategies in the coming years will be increasingly influenced by ESG considerations: “Evolving strategies could gradually reshape some insurers’ credit profiles, potentially with implications for ratings.”
"Environmental degradation caused by corporate activities is often associated with human rights abuses, so merging these two concepts under the same framework is a natural first step."
It added that environmental risks have been in the spotlight due to several devasting windstorms and wildfires, but social risks, such as the mis-selling of investment-oriented products, and governance risks, for example, intra-group transactions, are also important ESG considerations for insurers.
Specific ESG ratings scores have taken on heightened importance amid turbulence in the equity markets. A recent white paper from EY-Parthenon noted that capital continues to flow into ESG funds and that the continued growth of green and sustainable funds means insurers must actively monitor and promote their ESG ratings to retain full access to capital and manage the potential impacts on their stock price.
“That’s why ESG ratings need to feature prominently on the agendas of senior leaders and boards. Indeed, ESG scores can be viewed as the ‘front window’ into ESG strategies that go beyond baseline reporting,” EY-Parthenon says.
On the basis that companies’ good ESG performance is linked to positive financial performance as well as mitigating reputational and liability risks, most prominently greenwashing liability risk, it is very likely that credit rating agencies as well as investors will increase their focus on ESG performance, says Zaneta Sedilekova, associate at Clyde & Co. “Indeed, the three most prominent [insurer] rating agencies, Standard & Poor’s, Moody’s and Fitch Ratings have each incorporated ESG themes into their credit rating methodologies using their own methods, and we expect this trend to continue," she says. "A key issue is the extent to which these ratings define materiality by reference to the ESG impact the company is having on others, as well as the risks those issues present to the company’s financial wellbeing.”
Red lights and greenwash
A big part of maintaining a strong ESG rating for themselves involves insurers being aware of their insureds’ and their invested assets’ ESG performance. “As asset holders, insurers look at ESG ratings on the back of the increasing understanding that there is a real risk in separating financial performance from the business’s ESG performance, including its role in the wider economy,” says Clyde’s Nigel Brook. “A strong ESG rating often demonstrates long-term planning and focus on resilience on the part of the company given the global shift towards a net zero and nature-positive economy.”
Insurers and their clients both need to avoid paying lip service to ESG for the sake of marketing, however. Greenwashing ESG criteria is a growing risk for both parties, especially in Europe where activists hold corporate ESG statements to close scrutiny.
...we have not reached ‘peak ESG’
A number of strategic cases have been brought against high-profile corporates, most prominently the case alleging consumer-facing greenwashing against the Dutch airline KLM filed in spring 2022. In the UK, several corporates, including HSBC, have been found liable for greenwashing by the UK advertising watchdog, the Advertising Standards Authority, and ordered to withdraw their ads. “We have no doubt this trend will continue to have significant impacts on both insurers and their clients,” Brook says.
Neil Prior, group head of environmental and social responsibility at the broker BMS believes it is inarguable that ESG must be taken seriously by the insurance industry: “ESG is not a passing trend, we have not reached ‘peak ESG’ and we can expect greater (although better focused) demands on the sector’s performance across all three dimensions of corporate sustainability,” he says.
“If the sector has ESG ‘concerns’, it is that the urgency for improvement within the three pillars of ‘E’, ‘S’ and ‘G’ vary hugely throughout the industry and even more so in the industry sectors that the brokers represent and the underwriters support.”
In-house ESG initiative
How should insurers respond to a growing focus on ESG in terms of their management and allocating resources? Oxbow’s Philip Allan says that insurers who want to be leaders in the space should be thinking about global initiatives and net-zero plans: “This requires significant capital and time investment. Typically, we'd see dedicated ESG resources and Chief Sustainability Officers to drive action at the board level.
To make sure insurers are keeping up with market trends and competition, it is imperative that resources are also allocated to what are currently perceived as emerging ESG issues
“Those insurers who are happy being ‘members of the pack’ can't be complacent though. Mandatory requirements are expanding and managing this side of desk is becoming less of an option.”
Clyde’s Sedilekova agrees, pointing to insurers like Allianz Global Corporate & Specialty (AGCS) that recently formed a dedicated in-house organization for managing ESG activities. Gabrielle Durisch is joining AGCS from Zurich Insurance Group in April 2023 as the new global head of ESG & Sustainability Solutions.
Such a key first step in internal management of ESG criteria demonstrates a true commitment, Sedilekova says. “Often, however, the focus is very much centred on climate while many other factors under E, such as loss of biodiversity and plastic pollution, are not given enough attention. The same can be said about S and G.
“To make sure insurers are keeping up with market trends and competition, it is imperative that resources are also allocated to what are currently perceived as emerging ESG issues, so as to build internal preparedness for when these issues become financially material.”
