Whether it’s the Methodist church’s 19th century guidance against investing in “sin stocks,” the anti-apartheid South African divestiture movement of the 1980s, or more recent calls for greater transparency in diversity, equity and inclusion (DEI), evaluating organizations based on their track records on environmental, social and governance (ESG) criteria is nothing new.
More recent phenomena, however, is the use of ESG criteria by insurance companies in evaluating a company’s risk profile. As a result, there is a tangible impact on a company’s bottom line for its ESG strategies. Insurers still want to know if a company may face increased loss exposure from traditional risk. But ESG risks and opportunities are now driving different kinds of risk evaluation as well.
ESG risks and opportunities can include such disparate things as a company’s corporate ethics rules, its policy toward renewable energy, or its investment in DEI. These are particularly important when considering risk in such lines as Directors and Officers (D&O) insurance, as scrutiny has grown on governance issues like executive compensation and corporate ethics, and Employment Practices Liability Insurance.
Members of the board may also find themselves facing scrutiny over social concerns such as community impact. One potential risk is the threat of shareholder lawsuits over a company’s failure to fulfill its commitments around DEI. While reputational risks are nothing new, they continually rank among the top 10 risks faced by companies, a category of risk that is largely driven by ESG.
ESG issues will likely continue to be important for the foreseeable future, so risk managers should ensure that they have a clear ESG risk agenda, including working with corporate leadership to address ESG risks before they impact their risk management program.
Four Steps Toward ESG Mitigation
An effective ESG strategy can help mitigate risks amid increased underwriting scrutiny.
Identify Materiality Factors
Not all risks are the same, and not all ESG risks are the same. For example, highly regulated companies like medical device manufacturers will need to have a more robust corporate ethics policy than other industries. Your board should already be addressing ESG as part of the larger company strategy, but your insurer may want additional information about that strategy. For many public companies that means looking at what top investors deem to be material, including human capital management, cyber security, climate change, etc.
Identify where it is cost-effective and beneficial to make improvements, always keeping an eye toward maintaining and increasing shareholder value and building corporate sustainability. Take stock into what your current ESG strategies are, what your current practices are within various ESG factors, and whether you have any gaps relative to practices against stated goals and objectives and your industry peers. This provides helpful data points to gauge whether you are an outlier or not. Addressing risks before they become major is as important for risk managers. Don’t be afraid to implement reforms before problems are obvious to outsiders. One thing that all companies should have learned from the recent past is that bad practices, bad strategy and bad corporate behavior will be found out, and those companies will suffer the consequences.
You will receive credit for stating your ESG intentions, but you get more credit from investors and stakeholders if you translate intentions into definable and measurable actions. That can be accomplished through external communications -- if you are not telling the world what you are doing you are not getting credit. The narrative around your ESG strategy should be positive and forward looking, rather than crisis driven. Your narrative should focus on results, both in the near term and farther down the road. Make sure your narrative driven by your own communications and not your competitors, media or regulatory agencies. Consistently communicate through such vehicles as your 10K/Q, proxy statements, sustainability reporting and your company website. Take command in communicating your ESG actions.
Monitor progress and continue to refine approach as material ESG factors and required disclosures will continue to evolve. This is not a one-and-done process. Consistently revisit where you are on the spectrum as many businesses are in different phases in their ESG journey. As this is an emerging field, companies may find that good ESG strategy is a moving target. That’s why it’s important to have a clearly articulated strategy, along with the resilience to know that the companies that adapt to the changing ESG landscape will be the ones to succeed.
While ESG is a company-wide issue, risk managers should be prepared to raise concerns with their boards. Where ESG was previously considered to be, at best a cost of gaining positive PR, it is now regarded as a genuine opportunity for innovation. In his annual message to CEOs, Blackrock Chairman Larry Fink was blunt: “Our conviction at BlackRock is that companies perform better when they are deliberate about their role in society and act in the interests of their employees, customers, communities, and their shareholders.”
Again, no strategy can eliminate all risk. But as insurers increasingly scrutinize ESG risks and opportunities, having a sound ESG narrative and strategy in place will ease underwriting concerns.