Why ESG may be the next big thing in insurance

Companies are changing their reporting practices to better reflect their commitment to Environmental, Social and Governance (ESG) factors. Underwriters should take note.

ESG ratings aim to measure a company's resilience to long-term, financially relevant risks. Companies that score well should benefit from improved terms across a number of different lines of insurance - employers’ liability, directors and officers, product liability, public liability - given their focus on mitigating risk factors that can cause significant reputational harm.

Insurers incorporate ESG metrics in their investment decisions however where they factor in their underwriting deliberations is less clear. ESG rating does not specifically form part of an underwriting submission yet but more generally, the approach and attitude to sustainability and ethics are scrutinised.

ESG factors feature prominently in investment considerations and are used in risk assessment strategies incorporated into both investment decisions and risk management processes. In many ways, ESG supersedes Corporate Social Responsibility (CSR) to arrive at a more accurate assessment of a company’s actions.

  • Environment factors refer to the company’s behaviour on environmental issues such as resource depletions, climate change, waste and pollution.

  • Social factors are related to the company’s treatment regarding people, workers and local communities, including health and safety issues.

  • Governance factors refer to corporate policies and governance, including tax strategy, corruption, structure, remuneration.

ESG factors have turned what were once non-financial, intangible factors in corporate performance into tangible and financial factors to investors, lenders, business partners, suppliers, customers, employees, regulators, rating agencies, financial analysts, and other stakeholders alike.

A report by Oxford University and Arabesque Asset Management showed  (opens a new window)that sound ESG standards lower the cost of capital, result in better operational performance and that stock price performance is positively influenced by good sustainability practices.

The insurers’ approach

Some insurers are following the lead of investors. Zurich, for example, has published a document (opens a new window) describing how the insurer applies ESG metrics in the underwriting process. When identifying a new risk or renewal of existing risk requiring an ESG assessment, the risk may be declined or referred to the compliance and risk decision group, depending on the outcome of the ESG assessment. With the latter, the group will gather data, seek advice from various internal experts and external risk analysis experts to carry out a more detailed ESG assessment.

Another example is Allianz’s corporate insurance subsidiary AGCS which operates an ESG Business Services unit to ensure that all potentially ESG critical business transactions are screened and assessed in-detail to allow informed decision-making. If ESG risks cannot be mitigated or reputational impacts are likely to affect Allianz Group, a transaction is escalated for a group-level ESG assessment to determine under which conditions the local underwriting can proceed.

In order to find solutions, AGCS engages in an ESG Risk dialogue with clients, improving the understanding of the risk in focus and increasing expertise on both sides to manage and mitigate the risks accordingly.

Communication and training initiatives for underwriters globally ensures awareness and understanding of critical topics and sectors as well as applicable processes to follow. 

AGCS has also started the integration of ESG screenings (opens a new window) into the underwriting front office tool that will be applied gradually by all lines of business at AGCS in the coming years.  An ESG screening helps insurers manage not only their financial risk exposure but also their reputational risk exposure.

ESG indicators have significant explanatory power to assess whether a company has a higher probability for experiencing future harmful events, according to research conducted by AGCS (opens a new window) together with research and investment consultancy The Value Group. Predictors help to spot a deteriorating situation before an event happens and can help companies understand whether they have appropriate measures in place to reduce the risk of reoccurring harmful events, according to the findings. The research shows that the better a company’s’ ESG performance is, the lower the probability of it experiencing incidents such as workforce-related accidents, being involved in reputation-damaging controversies or being fined by regulators or government bodies, according to Allianz (opens a new window)

In times of social media when information travels quickly around the world and negative publicity related to environmental, social or governance aspects has become an ever increasing threat to companies’ reputations. Insurers applying a similarly stringent ESG-based approach to investors in their underwriting decisions might become a reality. This could potentially enable those that score highly in ESG assessment to use this to their advantage with regard to their risk transfer arrangements.

Lockton works closely with companies to assess and mitigate their risk exposure and achieve the best possible outcome when renewing insurance policies.

Please share your thoughts on this topic with us. 

Rupert McLean, Risk Solutions