While the benefits of ESG are clear, this new dimension still lacks a global structure. COVID-19 has encouraged business leaders to implement new strategies in their organizations, however many are unsure what criteria to use or how to put them into practice. With global institutions ramping up their efforts on sustainability, insurers should lead the way and carefully consider how to best include ESG in their policies and what criteria is best when it comes to new products.
For now, ESG mostly impacts insurance companies that offer insurance-based investment products and distributors that provide advice on such products. In particular, European regulators have laid the foundations of a new regulatory regime which focusses on improving transparency. In its first phase, financial institutions must disclose how they internalize ESG factors in their investment models. However, this is only the beginning. At the moment, these factors have no impact on Solvency II (SCR) capital charges, however this situation is bound to evolve. In the context of ESG, in addition to complying with legal obligations, institutions should be proactive in incorporating market best practices. These environmental, social, and governance levers can have a profound impact on reputation in addition to the risk of non-compliance with regulations.
But how can the insurance sector prepare for this change?
In recent years, we have seen some insurance companies decide not to cover risks for companies involved in coal or oil derivatives. Other insurers are considering insuring environmentally sustainable niches. An example of this is insurers offering companies more advantageous conditions. Both pressures are contributing to an economic climate in support of changing the energy model.
On 10 March 2021, Regulation (EU) 2019/2088 on sustainability-related disclosures in financial services entered into force, imposing disclosure and transparency obligations on the financial services industry, aiming to make investors aware of the potentially adverse sustainability impacts of the products in which they want to invest and the need to promote more sustainable environmental and social features in those products.
To this end, the new regulation imposes several obligations on insurance companies offering insurance-based investment products. Among others, insurers must disclose how they integrate ESG risks in their investment decisions, both on their websites and in pre-contractual information. They must also produce regular reports on the ESG features of the products and state whether adverse impacts of investment decisions on ESG factors are taken into account or why not. Besides complying with the standard, the adoption of relevant ESG internal policies has also become an essential factor in achieving sustainability and good governance. It is not enough to offer ESG-compliant products. These same essential principles must also be promoted internally. For example, several insurance companies are trying to reduce their carbon footprint as much as possible by encouraging virtual meetings and reducing air travel.
Even though Regulation (EU) 2019/2088 already establishes the obligation to include information on ESG factors in remuneration policies, some financial institutions are going further by starting to link remuneration to the achievement of social, organisational, or environmentally sustainable objectives.
Sustainability is part of insurance companies' risks and opportunities not only because it is a focus of interest for their stakeholders but also as an external factor that affects their risk models. It is, therefore, necessary to integrate ESG metrics into policies and company strategies. It is also recommended that companies analyse the impact on labour rights, transparency for the end consumer, the environment, privacy and data security
Lastly, a word of caution. It is necessary to warn against "greenwashing" – the process of conveying a false impression or providing misleading information to make a company’s products seem more environmentally sound. The cost of association with such businesses could be high for insurers, particularly as regulators are expected to crack down harder on this practice. In addition, regulated businesses such as those in the insurance industry need to give detailed consideration on how they will comply with relevant reporting requirements. While associating with businesses investing in ESG has clear benefits, associating with businesses who are “greenwashing” might lead to difficult questions from regulators and in turn reputational damage for insurers so it is important to be cautious.
One thing is clear - with growing consumer expectations, ESG is becoming increasingly important for businesses and insurers alike. It can drive business opportunities, boost reputation and profile, affect balance sheet performance, and impact insurers’ relationships with policyholders, shareholders, and the communities in which they operate. ESG holds an enormous capacity for innovation and transformation for the insurance industry. The "what will people say" and power of public opinion traditionally associated with paralysing social censorship can be the driving force for change.
Pablo Muelas is a partner and Head of the Insurance and Reinsurance practice of Hogan Lovells in Madrid. He is widely recognized as a leading practitioner in the Spanish insurance industry.
This article first appeared in Insurance Day on 11 August 2021, please see related materials.
Authored by Pablo Muelas.
