What is environmental, social, and governance (ESG)?

Well, it’s a framework by which companies can assess what their impact is on the environment, society, and their means of ensuring their governance is appropriate for their wider business goals and ambitions.

Private companies, typically, are guided by the objective of creating shareholder value and maximising profit.

However, there’s been a recent change into how corporate entities think about their duties to the world, their social and environmental impact, and the way they govern themselves in a fair and transparent way.

Insurance and reinsurance markets are no different.

The reinsurance industry is unusually positioned in that its core products and cost of goods sold are directly impacted by ESG-related issues.

Climate risk, for example.

There’s a recognition that climate change is causing increased severity and frequency of extreme weather events; storms which, historically, may have been perceived as 1 in 100 year events, now appear to happen at far greater regularity.

Climate change is even topping emerging reinsurance risk radars, overtaking the likes of cyber.

How should the industry respond? And what are the implications for (re)insurance firms ESG initiatives?

The Financial Aspect of Environmentally Unfriendly Risks

Much of the large reserves of insurance and reinsurance earned capital is locked up in investments.

This places a burden of responsibility on (re)insurance companies to choose ethical investments; simply, ones that don’t pollute the environment or exploit workers.

However, things can get complicated.

The reinsurance sector works to protect individuals to help ensure that people are protected and safe and have the means to to be made whole if something bad happens.

Conversely, companies in the financial sector, for example, such as private equity firms, are able to invest and detract money into and out of markets for profit maximisation without the same ethical implication that’s inherent to the reinsurance industry.

This difference adds a level of complexity from an ESG viewpoint.

If you stop providing insurance in certain sectors, it's often not the executive leadership in those businesses that suffer, instead it’s the person with the job in the coal mine.

The (re)insurance industry can’t as easily turn its back on sectors, rejecting people’s ability to be insured feels rather inhumane.

Portfolio content, whether that's your insurance portfolio or investment portfolio, is one of the big challenges in regards to ESG initiatives, as well as the transparency around that data.

We’ve spoken with a number of underwriters about ESG-tracking for their portfolios; a common complaint is the difficulty by which it is to measure due to data inaccessibility in siloed, legacy technology.

Data should be able to show what and who’s being insured within a portfolio, allowing for the implementation of wider ESG policies.

Reinsurance data and data accessibility is the key, and one of the industry’s biggest problems.

The Cultural Shift Towards Greener Solutions

The value of Tesla compared to other automakers is a leading indicator that the market is bullish on electric vehicles, with other firms also making the shift towards renewables.

However, there’s also the recognition of potentially creating a new problem to solve the first; mining materials for production and manufacturing, plus the disposal and recycling of massive lithium ion batteries is a challenge yet to be overcome.

While the shift away from fossil fuels is on its way, it’s not happening, in some people’s view, fast enough.

Groups such as Extinction Rebellion recently held a protest outside of Lloyd’s of London, demanding that syndicates stop insuring fossil fuel projects.

The (re)insurance industry generally doesn’t discriminate when it comes to protection, it provides a safety net across the spectrum to those that need it, protecting people and companies transitioning out of old areas and into new areas with associated risk.

Very recently, activists claimed that Lloyd’s CEO is failing on market’s ESG commitments, effectively asking that Lloyd’s commit to marketwide rejection of certain classes of activity.

The response from Lloyd’s was that the situation is far more nuanced.

There are also pesky things like competition law that prevent cartel-like behaviour that forces certain buyers of insurance and reinsurance out of the market.

We are, however, seeing a paradigm shift with increasing commitment to withdrawing support for unsustainable practices.

Reinsurance is there to help companies, and those individuals who work within those industries, make a transition to more sustainable solutions and practices.

KWH, for example, recently just raised a $20 million funding round to focus specifically on projects related to green energy.

Improving standards also encourages better ways of working and we must enable that to continue.

Historically, insurance has had an important role to play in this regard.

For example, if you want commercial building insurance with lower premiums then get sprinklers installed for improved worker safety.

Want car insurance? Better have seat belts!

Evolving Towards Better Practices

ESG-related issues are undoubtedly affecting reinsurance portfolios.

The challenge is finding the balance between accommodating risk with a way to continue making money, otherwise reinsurance will no longer be an industry.

A clear problem here relates to companies who are unsupportive of the move towards more sustainable practices.

And if they remain in a space with less competition, as firms start to look towards renewables, that can result in more lucrative earnings for the remaining incumbents.

This is why unilateral action from the industry is key.

Ideally, the biggest polluters would be charged the most for the shared impact to the risk pool, similar to US health insurance where premiums are higher if you engage in detrimental behaviour, like smoking cigarettes.

Perhaps we’ll see a similar introduction into the (re)insurance space to help offset pricing for those who behave in a way that support ESG initiatives.

People are beginning to evaluate companies based on their commitment to, and policies around, ESG.

And not just to be seen as a company doing the ‘right’ thing.

Businesses with strong ESG policies have been shown to have better financial performance over the long-term.

They have been shown to offer greater returns than the wider capital markets, marking a positive, measurable evolution from the early days of ethical investing.

If encouraging better behaviour is also driving better performance, businesses will see greater returns, both financially and ethically.