Looking Ahead: Environmental, Social & Governance

The concept of Environmental, Social and (Corporate) Governance (ESG) is evolving in the insurance industry, and in the wider financial and business communities such that it is no longer a matter of compliance but is essential for survival. Insurers are looking at it from the perspective of how ESG issues impact insurance and investment portfolios, and also how insurance and investment portfolios impact the environment and society.

Climate change can affect access to affordable insurance, but also provides an opportunity for insurers to invest in companies and technologies that are working to address the issue—and the insurers that do so will have an advantage. Those writing directors' and officers' liability insurance or professional indemnity insurance need to closely consider the future and how they provide this insurance. Insurers will need to consider brand and reputational issues which might arise as a result of the decisions that they make.

The coronavirus pandemic has led to many issues being deprioritised but ESG remains high on the agenda and has highlighted the potential for disruption to everyone that climate change could bring. The pandemic has proved critical but climate change is even more fundamental.

There are differing standards and frameworks that make the agenda challenging to navigate but they share the same aim and it is not an option to abstain. It is said that, in 10 years' time, if you are in a sustainable business you might survive. If you are not, you won't.

Relevant frameworks for insurers include:

1. The UN Environment Programme Finance Initiative (UNEP FI) Principles for Sustainable Insurance (PSI) is a useful framework to reference. It highlights that the new opportunities and risks posed by ESG factors mean that insurers should change the risk factors they consider when managing their businesses. The PSI is motivated by the fact that as risk managers, risk carriers and investors, insurers can play a vital role in encouraging sustainable economic development.

Four main principles are outlined in the PSI framework:

• Embed decision-making ESG issues relevant to insurance business.
• Work together with clients and business partners to raise awareness of ESG issues, manage risk and develop solutions.
• Work together with governments, regulators and other key stakeholders to promote widespread action across society on ESG issues.
• Demonstrate accountability and transparency, regularly disclosing publicly progress made in implementing the principles.

2. Sustainable Finance Disclosure Regulation (SFDR). The EU regulation on sustainability-related disclosures in the financial services sector applies from 10 March 2021. The SFDR provides a harmonised set of ESG disclosure standards for financial market participants and therefore helps to achieve one of the key aspects of EU sustainable finance.

The SFDR applies to insurers selling insurance-based investment products, in particular, the increasing popularity of ESG funds. It is unclear whether the SFDR will apply to UK based insurers, however, it is likely that the UK will seek to adopt regulations that are similar as it works towards meeting the goals of the Paris Agreement. Account therefore needs to be taken of them now even if they are not directly applicable yet.

3. Task Force on Climate-related Financial Disclosures (TCFD). On 9 November 2020, the UK Government announced various proposals for the financial services sector in the UK to support the green economy. The key announcements included:

• In the UK, Climate Related financial disclosures will be mandatory by 2025 across the economy (including occupational pension schemes, insurers, banks and building societies, companies and asset managers) adopting the recommendations of the UK’s joint regulator and Government body, the TCFD).
• The roadmap to compliance requires large UK asset managers to comply with disclosure requirements as of 2022 and other asset managers by 2023. The TCFD’s principles-based disclosure recommendations focus on governance, strategy, risk management, and metrics and targets.
• The UK will implement its own green taxonomy, using the EU Taxonomy Regulation as its foundation. A UK Green Technical Advisory Group has been set up. This leaves scope for UK divergence from the EU Taxonomy Regulation.
• The Government will issue its first Sovereign Green Bond in 2021, subject to market conditions.

Next steps

In light of the increasing focus on ESG disclosures, and the growing recognition that managing ESG risks can create long term value for an enterprise, there will be pressure on companies, asset managers and other relevant market participants who are not yet making ESG disclosures to start doing so, even if it is not yet mandatory.

In preparation for the advancing regulation on ESG, businesses should:

1. Consider whether the business is in the scope of the new disclosure requirements;
2. Carry out an assessment of the impact of the SFDR at the firm and product level, including whether any products promote sustainability;
3. If they fall within the scope of the SFDR, ensure compliance by updating websites and pre-contractual and contractual documentation as soon as possible (given commencement date of 10 March 2021); and
4. Consider making or working towards proposed ESG-related disclosures, even if not yet within the scope of the SFDR, given increased stakeholder requirements.
5. Work towards TCFD requirements for disclosure.

This list is not exhaustive and all relevant regulations should be considered in terms of expected compliance.

ESG in practice

An example of how commitment to ESG is progressing, both directly and through influence, is seen in Lloyd's recently published report and approach. Lloyd's ESG commitments include the following:

• Encouraging all insurance undertakings in its market to allocate 2% of annual premiums towards innovative and sustainable products by 2022
• Developing a new risk centre, launching in 2021 which will undertake research into new insurance products to protect society from systemic risks, including climate risk
• Ending investment in thermal coal-fired power plants, thermal coal mines, oil sands and new Arctic energy exploration activities. This means that Lloyd's and Lloyd's market participants will end new investments in these areas from 1 January 2022, and will phase out existing investments in companies that derive 30% or more of their revenues from thermal coal-fired power plants, thermal coal mines, oil sands or new Arctic energy exploration activities by the end of 2025.
• The publishing of a road map that sets out how Lloyd's will become net zero in its operations by 2025 and will work with the market to support their net zero emission plans.
• Asking managing agents in the Lloyd's market to stop providing new insurance cover for thermal coal-fired power plants, thermal coal mines, oil sands, or new Arctic energy exploration activities from 1 January 2022 and to phase out renewal of existing insurance cover for these types of business by 1 Jan 2030 allowing the market time to help their customers' transition. Lloyd’s will consult with the market and policyholders and provide ongoing support and guidance during this period of transition.

In the run-up to the United Nations Climate Change Conference (COP26), Lloyd's will also consider how else the insurance sector can best support the global effort to address climate risk, and respond to the UK government's Ten Point Plan for a green industrial revolution.

In summary, expected action on ESG is accelerating and needs to become a central part of business strategy for all insurers.

Read our full report 'Looking Ahead in the Insurance Sector'.