ESG AND INSURANCE

The Environmental, Social and Governance (ESG) agenda has become an increasing priority for the financial services sector including insurers. The world has seen an increased focus from the public and political institutions on the ESG agenda. The Paris Agreement in 2016 was a landmark event for climate action with the adoption of a legally binding international treaty on climate change. Subsequently, there has been an increase in social justice considerations such as gender equality, social inclusion and diversity.

ESG — also known as sustainability — is made up of environmental, social and governance factors. It began emerging in the 1990s, with international events and frameworks such as the Kyoto Protocol and more recently the Paris Agreement and UN Sustainable Development Goals. These helped reveal the extreme necessity and urgency for all sectors to find appropriate solutions to unprecedented global challenges.

With the advent of the COVID pandemic, organisations have started to prioritise their ESG strategy and corporate stewardship. Notably, financial services are accelerating their activities in this space, with the stark realities of COVID have come a wider appreciation of macro level risks in general – climate change included – and how these factors can dramatically turn the business tables. For insurers, this includes integrating ESG within the core business and operations, as part of underwriting, investing and risk management decisions, and developing tailored ESG products and services.

The component parts of the ESG criteria are considered below, with examples of the financial and reputational impacts felt by companies who have been negligent in their focus on ESG responsibilities.

Environmental:?This component of the three factors examines a company’s impact on the planet from a positive and negative perspective. Typically, the following environmental credentials of a company will be reviewed and analysed when ascertaining their commitment to achieving sustainability goals. In 2010, the Deepwater Horizon oil spill negatively affected BP’s share price significantly. This was the worst accidental oil spill in history and had severe and devastating impacts on the local wildlife and ecosystems. Compensation paid out by BP ran into the billions of dollars in the wake of this disaster, that saw close to 4.9 million barrels of oil spilled into the ocean.

Social:?The Social component of ESG looks at the people-related elements which include issues that impact employees, customers, consumers, supplies, company culture and the society at large. Research shows that companies which excel in engaging their employees achieve significant per-share earnings growth when compared to their peers. In recent times, August 2020, Boohoo, an online retailer saw a slump in stock price (￡4.12 to ￡2.47 within a three-month period) following revelations about the operational and contractual conditions under which its workers were employed.

Governance:?A company which has robust governance, and a strong board of directors that relate well to different stakeholders, will eventually mitigate the potential risks of the Principal-Agent problem – that is, the risks that exist when there is no alignment between the shareholders’ and the management’s vision and actions. Earlier this year in March, Deliveroo’s stock market listing was at risk of being tarnished following allegations of the company’s treatment of its couriers. Additionally, a couple of the UK’s largest asset managers, including Aberdeen Standard, avoided participation in the IPO because of the company’s share ownership structure, which granted 50% of voting rights to the CEO. The concerns around treatment of workers have meant the allocation of more that ￡112m to cover potential legal costs should the employment status of its rider change if there is a future litigation against the company.

As very long-term custodians of assets, insurers are more exposed to sustainability issues than most other classes of investors – for them managing ESG exposures is arguably an existential issue. They are increasingly scrutinized by policymakers, as governments and regulators explicitly focus their ESG edicts on long-term investors including major asset owners, such as the insurance sector. Given that insurers globally control around $30 trillion of global assets,5 and that some of these assets are held for decades, it follows that ESG regulations should impact the insurance industry more than most. This regulatory push is expanding globally, so not only are insurers exposed to actual ESG risks via both their underwriting and investment activities, but to specific new regulatory risks too – posing a concern on two fronts. This considers how insurers assess and align to their ESG agendas from three separate perspectives. Firstly, from a purely investment focus; secondly, from an underwriting capability; and finally, from a business operations point of view.

Finally, life insurers face a specific challenge to ensure consistency across their own general-account investments and unit-linked investments, for which policyholders bear the investment risk. Some 41% of life-insurance companies are seeking to ensure a minimum standard across all their investment solutions. There are challenges here, however, because unit-linked products often include externally managed funds. The common strategy for life insurers is to ensure a solid ESG foundation in their general-account assets, primarily driven by risk-management considerations, and to give clients the opportunity to select unit-linked products that go beyond this minimum framework.

Some insurance companies are now aiming to achieve a competitive edge through sustainable products, including ESG model portfolios that offer clients unit-linked solutions entirely composed of ESG-labelled products. There is a clear opportunity here for companies to use their sustainability credentials to fuel growth and attract new clients.