ESG could be make or break for the insurance industry

Much of the attention on the insurance industry today comes from a technological perspective. If headlines are to be believed, digital transformation is the industry’s number one concern and its primary goal.

But in the race for competitive advantage and the pressing need to meet customer expectations, the appetite for ‘true’ digital transformation is not as strong as you might think. Instead, the biggest threat – and opportunity – comes from the Environmental, Social and Governance (ESG) side of the industry.

The evidence is irrefutable - companies that fully embrace Diversity & Inclusion and ESG produce better cultures and better results. They are better managed and will be more resilient over time.

First the good news: according to the second GARP survey, board-level governance on addressing climate risks exists at 90% of firms and engagement is increasing. The research found that there is recognition of both risk and opportunity in climate change, but that opportunities will have a bigger impact on strategy over the next five years.

That said, companies are concerned about reliable models and regulatory uncertainty and that getting everyone on the same page internally is still a struggle. UNEPFI finds that losses from climate change could lead to global costs equivalent to losing between 5-20% (a conservative estimate, the initiative notes) GDP every year, forever.

If that’s not enough to shock insurers into action, last year’s PRA guidance might prod carriers in the right direction. Following its May 2020 letters, it expects firms to take a “strategic and holistic approach, considering how climate-related risks might impact all aspects of their risk management”. If that doesn’t work, there is the threat of imposing a capital holdings increase if insurers don’t comply with climate change and diversity targets.

It’s not just regulation where insurers need to be wary. Shareholders and customers are also keeping an ever-closer eye on organisations to be sure they do more than pay ESG lip service. This is partly through financial interest – Munich Re found thatglobal losses from natural disasters in 2020 were $210bn but only $82bn of that was insured, significantly higher on the previous year.

Insurers are well versed in encouraging clients to be more proactive and focused when it comes to risk management; better risk management improves the client’s risk profile and hence they should see lower premiums, other things being equal. The same has to be true for ESG issues and, therefore, the insurance industry should be encouraging and helping their clients to improve in the ESG space and incentivising them to do so. This would add another layer of value to the insurance product, as well as building a more robust business for the carrier.

Covering the whole ESG spectrum

On the whole, insurers understand the Environmental aspect of ESG, if still struggling to meet the targets set. However, the social and governance elements are even more of a challenge. Recent analysis from Fidelity revealed that COVID had shown weaknesses here, in Governance particularly, around business interruption and ambiguous policy wordings. These had caused problems for both carriers and customers alike.

Others, such as DBRS Morningstar, suggest that more attention needs to be paid across the board, noting that the Social element including data breaches or product mis-selling carried both a reputational and financial risk. It has formalised 17 ESG factors into its rating process, making adherence “more explicit, as opposed to implicit”. In other words, these requirements have always been here, but to make financial services companies – and insurers in particular – more likely to meet them in full, they have been brought much more to the fore.

To meet regulatory deadlines and new ESG targets still presents insurers with a mountain to climb. From climate change to diversity, there is no part of the insurance business that remains untouched.

In terms of climate change, carriers will probably have to focus on next best actions – just because current targets are unattainable doesn’t mean they shouldn’t get as close as possible. Issues such as diversity and inclusion – which many insurers don’t even realise also falls within the purview of ESG - are more immediately solvable, provided insurers have the appetite to do so. All too often, it is simply a lack of ambition and a willingness to make diversity a priority. 

To succeed here, insurers will need to build a diverse human resources ‘pipeline’. They will have to proactively engage with their search agencies to make sure that diverse leadership is being built from the ground up for today, but also for the future. We need to make sure we have the right people in leadership for the right reasons.

Compliance across ESG, including managing diversity and inclusion is not some philosophical question. It’s a question of programme management. Of setting a series of defined goals that impact both a single organisation and the sector as a whole. Insurers cannot expect to go about their change programmes unsupported. They will need help, not to have roadblocks put in their way from the industry at large. Moving to a principle-based regulatory system will help. But transparency, due diligence and a commitment to compliance – to at least the spirit of regulation – are certainly the way forward.