ESG in insurance: how to keep up with ESG risks

Nousheen Hassan
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With ESG expectations getting more complex, it can be tricky to keep up. In the third article of our ‘Insurance Risk Management in 2023’ series, Nousheen Hassan looks at ESG for insurance companies and how to stay up to date on ESG risks.

Covering the three factors of environmental, social and governance, ESG is an inherently broad topic and one that’s often difficult to quantify. Insurance firms sometimes don’t know where to start, or how to develop their approaches from short-term initiatives to long-term strategic change. The picture becomes even more complicated when considering third-party risk, business portfolios and the wider supply chain, and the additional oversight these require.

ESG concerns are increasingly important to organisations, customers, investors and regulators, however. Insurance firms that act with purpose and can actively demonstrate their ESG values will not only increase customer trust, but build business resilience and protect against reputational damage.

E – addressing environmental concerns

The environmental factor within ESG is arguably the most tangible. Climate change and greenhouse gas emissions dominate the headlines but this category also includes: energy efficiency, resource depletion (including water), hazardous waste, pollution, deforestation, wildlife preservation and wider green initiatives.

From a regulatory standpoint, a lot of work is underway to quantify the financial risks due to climate change. For the insurance sector, firms face challenges around climate change exposures and aligning underwriting strategies, which may require exiting some portfolios. Insurance firms must also review their investment portfolios to ensure 'green’ investments wherever possible. This will undoubtedly impact the firm’s financial risks.

Financial loss may also arise from transition risk, where legislation, regulation, or internal measures to reduce climate change may have an indirect impact. The Task Force on Climate-related Financial Disclosures (TCFD) has developed guidelines on disclosing these risks and providing guidance to firms for good disclosure practices.

The PRA has also published SS3/19 which outlines expectations for banks and insurers to manage the financial risks due to climate change. This includes requirements on governance, risk management, scenario analysis and disclosures. The recent thematic feedback on the PRA’s supervision of climate-related financial risk and the Bank of England’s Climate Biennial Exploratory Scenario exercise, highlights the considerable efforts to date but reiterates the need for further work in all areas. This includes improving risk management frameworks, refining scenario design and use of models, making more detailed disclosures and bridging data gaps.

Read more on the PRA’s expectations on climate risk management.

Looking beyond regulatory expectations, customers, investors and stakeholders are increasingly concerned about sustainability, and want to work with firms that care about the environment and take meaningful action to protect it. There are also liability risks to consider. Firms that misrepresent products, don't take appropriate action to reduce environmental harm, or provide misleading ESG reporting information may face legal action in the future.

Read more on ESG litigation risks.

S – driving social change

The social element of ESG includes diversity, equity and inclusion (DE&I), health and safety, employee engagement and labour issues, among others. It reflects the growing demand for insurance firms to behave ethically and purposefully, with greater accountability around an organisation or individual’s behaviour.

DE&I is a key area where expectations and practices are fast evolving. More and more insurers recognise that a diverse workforce supports diversity of thought and outcomes. To improve DE&I approaches, insurance firms need to create accessible recruitment processes that capture a diverse range of candidates and treat everyone fairly. These practices need to be supported by a culture that encourages people to bring their 'whole self' to work, empowering individuals to speak up and make an active contribution within the workplace. Providing opportunities for training and professional development will help diverse candidates progress throughout the organisation. In the long term, this will help retain talent and ensure the firm is building an inclusive and diverse workforce.

Firms that don't adequately address social factors risk reputational damage, financial losses and legal action. High-profile modern slavery claims in fast fashion, for example, have led to significant impacts on share prices and customer loyalty. Similarly, there are debates around the classification of workers as employees or self-employed contractors (with a subsequent question over the right to minimum wage and holiday pay). In time, greater legislation and regulation will address some of these behaviours, but it’s important that insurance firms act in good conscience, and take preventative measures. 

Third parties and the supply chain are also a key consideration when it comes to social factors but are often overlooked. This is particularly challenging as social elements are arguably the least tangible. Deficiencies here make it difficult for insurers to compare suppliers, or track social performance throughout the supplier life cycle. (However, work is underway in this area through the recently announced standardised ESG ratings in the Edinburgh Reforms, giving all stakeholders more consistent information on all three factors). Making sure all supply chains act responsibly and support an insurance firm’s wider ESG strategy will help reduce reputational damage, maintain the customer base and fulfil organisational goals.

G – improving governance

Governance factors include corporate governance elements such as executive pay, board structure and remuneration policies. It can also include corporate behaviour such as conduct, business ethics, and anti-bribery and corruption policies.

In the insurance sector, governance frameworks are well established and supported by the Senior Managers and Certification Regime (SM&CR), setting key responsibilities from board level through to senior management functions. These are bolstered by clear conduct rules, and more recently, new Consumer Duty requirements to ensure good customer outcomes.

Despite significant regulation in this space, governance failings can and do happen. Lack of oversight, a poor working culture and inadequate products being offered to customers can lead to improper conduct resulting in negative outcomes for employees, customers, investors and other stakeholders. Poor governance can also lead to misrepresentation in financial reports or other disclosures, leading to potential legal and regulatory risks. In addition to the associated ethical and regulatory implications, the reputational damage can be long-lasting and it can take time to rebuild customer trust – an integral element of the insurer-client relationship.

Effective governance relies on a diverse board with a good mix of skills and expertise from both executive and non-executive directors. This includes ongoing training and up-to-date terms of reference on emerging topics to help the board assess the risk profile, set risk appetites and establish the strategy.

Insurance firms need to embed risk management approaches through a strong controls culture, supported by policies and procedures, with responsibilities and accountabilities ingrained across all three lines of defence. An incentive programme will encourage the desired behaviours and drive quality across the business. Good reporting processes will help insurance firms monitor their risks and help senior management make informed decisions.

Putting customers at the heart of all business activities will help insurers maintain successful governance processes and ensure good consumer outcomes.

Watch our webinar on corporate governance disclosures in financial services.

Six considerations for tackling ESG risk

Fundamentally, ESG is about behaving ethically and morally, and all stakeholders require tangible evidence of these behaviours. Boards need to set risk appetites that align with the firm’s ESG strategy and ensure that internal policies, processes and personnel do their best to adhere to these appetites and to manage the ESG risks in the business.

Insurance firms that can capture key ESG risks within their wider risk management framework will be well placed to embed effective strategies and controls to mitigate ESG risks. To achieve this, they need to assess how they're embedding ESG factors within their organisations and progress to date. Key considerations include:

  • the firm’s wider goals and underlying values – to be set at board level
  • determining which areas need to be addressed and prioritised – based on the firm’s purpose and risk appetite
  • the investment needed in terms of cost, time, resources, skills and expertise
  • identifying key personnel to establish and participate in an ESG taskforce
  • embedding ESG initiatives into the risk framework to monitor and track risks as they arise
  • creating processes for ongoing monitoring and horizon scanning as the ESG landscape continues to evolve.

Taking steps now to improve the ESG framework will set insurance firms up for long-term success, helping to meet all stakeholder expectations, improving resilience and build a stronger business.

For more insight and guidance on building a strong ESG framework, get in touch with Nousheen Hassan.

ESG and climate change

What should you do now to develop and embed effective climate risk management processes?