The ESG Drumbeat – What Does it Mean for Insurance Companies?

The growing drumbeat of ESG measurement and reporting is working its way into nearly every industry in the U.S. and worldwide. Its effect on the insurance industry is most pronounced today among the large carriers, but smaller and medium-sized insurance companies are increasingly responding to emerging regulations and industry standards with their own reporting.

Many people – including in the insurance industry – undoubtedly are skeptical about the value of ESG reporting. But an enormous number of voices, backed by political will, are demanding action and change from organizations on this front. For some people, ESG reporting may just be a compliance exercise, but for others, it will be an integral part of business strategy and a way of differentiating themselves in a crowded marketplace.

The challenge over the next five years for most insurers will be to produce meaningful ESG metrics that accurately reflect their operations. No one needs to start from scratch. There is a host of established metrics ranging from free carbon consumption tools to reports provided by asset managers as to how green your investment portfolio is.

What is ESG reporting?

Standing for environmental, social, and governance, “ESG” refers to a broad values-based set of practices redefining business management and investing. For publicly traded or heavily regulated companies, adherence to ESG practices is increasingly becoming imperative.

The move toward ESG awareness and reporting places significant focus on the investment world, where increasingly more funds built around socially responsible and environmentally sensitive investing are appearing on the market. Since the insurance industry revolves around investment portfolios, ESG reporting rules written by a variety of standard-setting organizations and taking effect over the next five years will compel insurance companies of all sizes to report ESG analyses of their operations and investments.

Underlying the growth in regulations and ESG reporting requirements is the belief that high-quality disclosures about how organizations and assets will be impacted by – and how they will impact – environmental change will improve transparency, encouraging better-informed pricing and capital allocation. In turn, this should drive investment in more sustainable projects and activities.

Who is setting the standards?

Thus far, other countries have taken the lead in supporting recommendations from the Task Force on Climate Related Financial Disclosure (TCFD), created by the Financial Stability Board, an international body that monitors and makes recommendations about the global financial system. But action in the U.S. is picking up steam.

The Securities and Exchange Commission (SEC) has proposed several rules governing investment funds that are promoted as focusing on ESG-aligned values to ensure that consistent, comparable, and reliable information is provided to investors. Funds that have ESG references in their names are a particular focus, with a new rule requiring at least 80% of their holdings to be ESG investments.

In 2021, the SEC created the Climate and ESG Task Force under the division of enforcement, signaling the Commission’s belief that false and misleading statements were being made about ESG investments and funds. Around the same time, the SEC proposed rules that would require information about climate-related risks that are likely to have a material impact on business results and financial condition. The required disclosures follow the TCFD principles, and they include required disclosure in the notes to the financial statements.

In April 2022, the SEC took its first action on ESG, filing a complaint against Vale SA, a Brazilian mining company, alleging fraudulent ESG disclosures.

Besides regulators, significant pressure to embrace ESG practices and reporting is coming from investors, board members, and consumers in the U.S. According to the 2020 EY Climate Change and Sustainability Services Institutional Investor Survey, 34% of respondents said companies do not adequately report environmental risks that could affect their business models. Similarly, 41% said companies did not adequately report social risks, and 42% said companies didn’t adequately report governance risks.

This dissatisfaction with the level of reporting and transparency in ESG investing is likely to grow as the prevalence of ESG-related investment vehicles continues to burgeon. An S & P Global Study estimated that issuance of sustainably linked bonds had topped $1 trillion as of 2021.

What does it mean?

What does all this mean for insurance companies?

In 2010 the National Association of Insurance Commissioners established a climate and resiliency task force and adopted a Climate Risk Disclosure Survey. The survey was sent to companies that wrote $500 million or more in premium in 12 states.  In April 2022, the NAIC adopted a report that aligns with the TCFD. The revised TCFD-styled disclosure will be due to regulators in November 2022.  The current threshold for participation in the survey is $100 million in premium.

These surveys are available on the California Department of Insurance website. Some companies submitted TCFD-styled reports as early as 2020. At least 26 such reports covering 293 insurance companies – mostly larger international insurance groups – can be found on the website.

The trend is clearly moving to more ESG reporting by more companies at all size levels within the industry.

Guidance and regulations in this area are based on the principle that the response needs to be proportionate to the level of risk that climate change represents to a specific organization. We have guidance on the different types of risk – physical risks from extreme weather events, which may mean that underwriting techniques need to be revised. Also, there are transition risks. For example, if your insurance company holds large investments in long-dated debt issued by a coal mining company, you may be concerned as to the value of the investments as the world moves away from coal. For some, these risks could have a massive financial impact that should be disclosed to all stakeholders.

So, ESG reporting is primarily an exercise in evaluating changing levels of risk based on environmental, social, and governance practices, quantifying the risks, and disclosing them to investors, employees, customers, bankers, and other stakeholders.

The fundamental principles are that disclosures should:

• Represent relevant information.
• Be specific and complete.
• Be clear, balanced, and understandable.
• Be clear over time.
• Be comparable among companies within a sector, industry, or portfolio.
• Be reliable, verifiable, and objective.
• Be provided on a timely basis.