ESG finds a home in the insurance industry

Industry would be wise to pay attention to ‘environmental patterns’

While ESG is the bugbear of the GOP’s vision of “woke capitalism,” it has found a home in the insurance industry.

“ESG is in the insurance industry’s DNA,” says Michael Leonard, chief economist and data scientist at the Insurance Information Institute, an assertion widely shared within the industry.

“It would be very difficult,” he added, “for the insurance industry to insure in an economically viable and sustainable way without paying attention to environmental patterns.”

Insurers identify and price risks, of which the most significant are the effects of climate change. “There is not an industry more directly affected when you think of the cost of fires and floods and droughts than the insurance industry,” writes Steven Rothstein of Ceres, a nonprofit advocacy group.

In 2021 Swiss Reinsurance Company, among the world’s largest reinsurers, reported that “from 2010 to 2020, realized loses have exceeded expectations in almost every year. Very likely, part of this gap can be attributed to trend effects due to climate change.”

While controversy has arisen over ESG investing, Grant Foster, managing director of Aon Global Risk Consulting, notes “Investment is not the only reason to brush up on an organization’s ESG credentials; the ability to access the insurance markets is also increasingly reliant on ESG performance.” And insurers are gatekeepers to broader capital markets.

Insurance is about managing risks, and insurers straddle a pair of them on the asset and liability sides of their balance sheets. As investors insurers manage large portfolios to defray the liabilities, they assume by underwriting the risks born by their policyholders.

Coined in 2005, ESG — environmental, social and governance — represents factors which pose material risks to a company’s financial performance while reflecting its commitment to sustainable development and civic responsibility. In other words, ESG rests on the presumption that the fortunes of public companies are not solely determined by quarterly earnings and stock prices but also by how they address issues like climate change, social diversity, labor relations and their relations with the communities where they operate.

Measuring ESG with reporting

A survey conducted by PricewaterhouseCoopers found that 85 percent of global insurers believe ESG will affect all aspects of their business, with 91 percent reporting it will bear on their investment portfolios, and 88 percent reporting it will play into their underwriting policies.

Although ESG reporting is not mandatory, companies are increasingly disclosing their ESG profiles as measured by scoring systems developed by firms like Sustainalytics, MSCI and RepRock.

These systems assign metrics to factors like handling carbon emissions, addressing climate change, managing waste disposal, employing a diverse workforce, painting safe workplaces and compensating executives. The metrics are open to question and beset with anomalies, not least because of the subjectivity of some of the factors, and continued to be developed and refined.

A study by Howden Group Holdings, an international insurance broker, and Fidelis Insurance Group, a specialty insurer and reinsurer, found that high ESG ratings improve underwriting performance. The study, the largest yet undertaken, matched loss ratios across 30,000 policies with a premium value of $9 billion against the ESG ratings of a third party. Environmental ratings showed the strongest correlation with loss ratios and property insurance the strongest correlation between high ESG scores and low loss ratios.

For insurers, ESG is a risk management tool applied to both their underwriting policies and their investment strategies. For instance, in 2019 Chubb, the largest publicly traded property and casualty carrier in the world, announced it would no longer underwrite the construction and operation of new coal-fired power plants or cover new risks for companies drawing 30 percent or more of their revenue from mining coal or generating energy from it. Nor will Chubb make debt or equity investments in such enterprises.

Two years later, Chubb withdrew its coverage of the Trans Mountain pipeline project in Alberta and announced it would no longer underwrite tar sands projects. And in January, the company announced the formation of a “global climate business unit” to provide products and services to businesses developing strategies and technologies to reduce dependence on carbon.

Likewise, Lloyd’s of London has stopped investing in thermal coalfired power plants and thermal coal mining operations as well as tar sands projects, while undertaking no new energy activities in the Arctic. The company will phase out its existing investments in firms that derive 30 percent or more of their revenues from coal-fired power plants, coal mines or tar sands by the end of 2025.

“Insurance is the Achilles’ heel of the fossil fuel industry,” Peter Bosshard of the Sunrise Project told Fortune, “and without insurance the industry can’t attract capital.”

Insure Our Future, an alliance of advocacy groups, recently reported that 62 percent of reinsurers expect to withdraw coverage of coal mining operations and power plants while 38 percent, including MunichRe, among the world’s largest reinsurers, plan to shed coverage of new oil and gas fields.

Governing ESG

Until recently, controversy over ESG was confined to ESG investing. In November 2020, the Biden Administration announced it would reverse a rule adopted by the prior administration prohibiting fiduciaries from applying nonpecuniary criteria in managing retirement accounts.

When the rule took effect in January, 25 states — 23 including New Hampshire with Republican governors and two with Republican attorney generals — filed suit to enjoin it.

Recently the House and Senate, by narrow margins, adopted resolutions to overturn the rule, which President Biden vowed to veto. Since 2020, 18 states, all governed by Republican majorities, have enacted more than 40 laws to prohibit or penalize financial firms that apply ESG criteria to their investment decisions.

In the United States, the insurance industry is regulated by state — not federal — government. This month Texas, which has been at the forefront of the campaign against ESG investing, became the first state to train its fire on the insurance industry.

Recently, a bill was introduced to prohibit insurers from using ESG metrics in underwriting policies and setting rates and withholding coverage from “an entity involved in otherwise legal activity for the purpose of achieving environmental, social or political goals.”

While the sanctions Texas imposed financial firms prohibited them from doing business with government entities without preventing them from serving corporate and retail clients, those aimed at insurers using ESG metrics would bar them from conducting any business at all in the state.

“We don’t want to destabilize the entirety of the insurance industry by injecting a bunch of nonactuarially sound principles,” said Texas Rep. Tom Oliverson.

The bill’s sponsor, Senator Bryan Hughes, refers to ESG as “Everyone Suffers Guaranteed,” and said, “If they’re going to mess with the money that belongs to Texas retirees and undermine the very Texas economy, we’re gonna teach them some manners.”

Categories: Banking and Finance