Environmental, Social, & Governance (ESG) is set to dominate the way corporates conduct business for decades to come. Insurance undertakings are uniquely placed to play a pivotal role in the ESG revolution. There are significant opportunities for those that embrace it.
The Central Bank of Ireland (CBI) has outlined its expectations for Regulated Financial Service Providers (RFSPs) under its supervision. All RFSPs will be familiar with the increase in general governance requirements over the past ten to fifteen years. However, most are still at very primitive stages in developing appropriate Environmental and Social standards.
This article by Gary Stakem, Director of our actuarial practice, outlines ten steps on how insurance undertakings can leverage their governance and risk frameworks for success.
1. The board: Set the tone from the top
To empower the risk function, the Board must set an example, and make it clear that ESG is a top priority for the company:
- Boards will have stated responsibilities and defined objectives, but few adequately cover ESG in their terms of reference. This is a good place to make a statement of intent.
- Most board meetings don’t include ESG as a standing agenda item. Regulators will expect improvements on this. Smaller undertakings should schedule ESG on the agenda at least annually. Larger firms might consider it an essential standing agenda item. Scheduled and structured discussions at Board level will be a positive first step;
- The next step is to set clear expectations to executive management on ESG strategy, responsibilities, standards and reporting expectations. Defining budgets for ESG initiatives would also be helpful.
2. Broaden the psyche: ESG risk identification and brainstorming
EIOPA and the CBI have been clear on their expectations regarding climate scenario analysis. Before quantifying and mitigating these risks, insurers must better understand the threats (and opportunities).
Climate risk identification exercises need to be broad and deep. Some firms barely consider the impact of melting ice-caps and extreme weather events; much more rigour is needed to fully consider their second and third order impacts. There are many questions for insurers, such as:
- What are the threats and opportunities that motor insurers face with transitions to electric vehicles? Are historic pricing and reserving models fit for purpose?
- Are life undertakings adequately considering the impact of electric (and increasingly AI driven) vehicles on mortality rates?
- What impact will the shift away from fossil fuels have on morbidity rates and health in general?
- How are D&O and other liability insurance products exposed to the prospect of increasing climate protection regulations?
- How will carbon taxes influence the way people and cargo travel? How will this impact travel insurance, marine, aviation and other forms of transportation insurance?
- What impact will ‘green investments’ have on pension funds, investment products, and the assets of the insurers itself?
Firms should first think broad and deep on the range of ESG implications. Only then can they begin to understand and assess risks in the context of their own operation.
3. Revamp the Risk Appetite Statement
Most Risk Appetite Statements (RAS) make limited reference to environmental and social issues. This overlooks the risk that climate change poses to the firm, but also the risk the firm poses to the climate. Reviewing the RAS through an ESG lens might unveil several shortcomings. Areas to consider include
Underwriting appetite - the RAS should define acceptable levels of underwriting concentration to climate related events. But insurers may also wish to look at limiting their capacity for covering risks that are harmful to the environment and increasing capacity for insuring greener activities.
Investment appetite - the company’s investment guidelines should be reviewed and updated in relation to ESG. If the firm invests in equities, it might increase its allocation to ‘green’ funds. Investment in corporates with poor human rights records might be prohibited.
Operational appetite - Insurers should be thinking of the carbon footprint of their offices, employees, remote workers, business travel arrangements, IT, and energy efficiency practices. They should also be cognisant of social issues like Diversity & Inclusion.
4. Incorporate ESG into governance policies
ESG tolerances should be reflected in governance policies and translated into specifics on:
- what will be done.
- when it will be done.
- who is responsible for doing it, monitoring and reporting.
5. Internal controls and KPIs: What gets measured gets managed
While revamped Board Objectives, Risk Appetite Statements, and Governance Policies are a good start, firms should be wary of creating false promises and falling into the ‘greenwashing’ trap. The risk function can ensure that the words on paper translate to action on the ground.
A gap analysis of the current framework against ESG aspirations will go a long way. Internal controls should be consistent with the risk appetite, board objectives and governance policies.
Appropriate reporting and escalation of ESG control failures is of critical importance.
6. The ORSA
The ORSA is an established risk management tool that can add value in navigating ESG uncertainty. ESG analysis should go hand in hand with every aspect of the ORSA process and it should be core to the business planning feedback loop. Insurers should aim to have climate intrinsically baked into all stresses and scenarios in the same way the general economic landscape is currently.
The ORSA must be designed to answer the critical questions unique to each individual company. The ORSA results must enlighten Boards and senior decision-makers as they future-proof business strategies for the considerable change that is on the horizon.
7. ESG Gap: Analyse the product offering
Insurers would also be wise to Perform ‘ESG Gap Analyses’ across their entire product offering. There is a crucial question to be asked. In one/five/ten years’ time will the current product offering:
- Continue to satisfy underwriting appetite in the face of rapidly evolving climate risk?
- satisfy increasing regulatory requirements?
- reflect well upon the company’s brand and reputation?
- continue to be marketable to an increasingly ESG contentious target market and meet their evolving insurance needs?
If the answer to any of the above is no, then action plans are required.
8. ESG horizon scanning
Most firms still don’t have a systematic or proactive approach for monitoring ESG developments. An effective Horizon Scanning process will bring key ESG developments to the attention of Board and Management and can hence influence organisational direction. Following the opinions of leading climate scientists and policy experts can help firms understand the implications of extreme weather, changing government policies, taxation shifts, and wider societal behaviour.
9. Leverage the Third Line: Internal audit & ESG
Engaging the third line of defence on targeted ESG audits will provide an additional layer of assurance to the Board and is a tangible indicator of the firm’s commitment to progressing its ESG agenda.
The firm can also bring ESG considerations into the scope of other internal audits. For example:
- If auditing outsourcing arrangements, is ESG adequately considered as part of supplier relations? Is ESG part of the due diligence process for new outsourced providers?
- If auditing product oversight, is there evidence that climate considerations are an inherent part of the product review process?
10. Foster the right culture: Zero tolerance toward greenwashing
‘Greenwashing’ refers to the practice of exaggerating sustainability efforts or misleading customers to make them believe products and services are eco-friendlier than they really are.
Similarly, some firms may boast of their commitment toward Diversity & Inclusion matters by making statements on social media or by forming D&I committees. But are these committees actually empowered to bring about change?
Appoint a risk management champion who can steer the firm away from box-ticking risk management exercises and instead focus on measurable outcomes. The risk function can similarly act as the guardian against greenwashing. Firms should be held to account on tangible outcomes on areas like gender balance, energy efficiency and green investments.
Change is coming. Regulators expect it. Society expects it. And insurers are uniquely placed to significantly shape what comes next.
Most firms are willing to accept the challenge. But despite the good-will, there is a clear danger that organisations fail to transform their well-meaning words into actions. For that reason, the risk function is the ideal custodian to ensure ESG objective are met. An ESG-enhanced Risk Framework is the perfect tool to realise success. The Board must set the tone from the top and ensure the Risk Function is empowered and resourced to champion this cultural change.