By Tim Garza, Director, Insurance Strategy & Solutions.
Environmental, Social, and Governance (ESG) was first coined as a term in 2005 and built upon the older principles behind Socially Responsible Investing (SRI). SRI simply focused on blocking investments into certain sectors such as Alcohol or Tobacco.
ESG is much broader now: it focuses on helping investors and institutions alike zero-in on the types of investments and activities that will help advance ESG’s three pillars.
This is a much bigger ask to companies than just saying “no” to an investment. Instead it requires the appropriate strategy, data governance and controls to make an insurer’s strategy a winning one.
ESG demand is growing
Demand for ESG is coming from all stakeholders: investors, customers and public entities, among others. First, investors are growing weary of the news around climate change and more activist style investing is taking hold.
For example, the Swiss Re Institute recently warned that an average temperature increase of 3.2 degrees could wipe out 18% of global GDP by 2050. These are real dollars on the table.
Demographically, ESG demand is primarily coming from Millennials. In a global survey conducted by Nielsen, 73% of Millennials (defined as born between 1977-1995) are willing to pay more for sustainable goods and services. As a whole, 66% of the global public is willing to do the same.
Companies with an ESG focus are enjoying a sustainability premium on their value
This demand is translating into the corporate world and is beginning to forge a divide between companies based on the strength of their ESG programs.
Investors and consumers want to know the impact that their dollars are making in the world. In 2018, Blackrock CEO Larry Fink wrote a famous letter to fellow CEOs with a very direct message, which the New York Times summarised as: “Contribute to society, or risk losing our support”.
As a manager of $6 trillion in assets, Blackrock’s message goes a long way, and it was heard loud and clear across the corporate world. Mr Fink adds that companies must serve a social purpose: “To prosper over time, every company must not only deliver financial performance, but also show how it makes a positive contribution to society”.
Mr. Fink has continued to push this narrative into 2021, adding, “It’s not just that broad-market ESG indexes are outperforming counterparts. It’s that within industries – from automobiles to banks to oil and gas companies – we are seeing another divergence: companies with better ESG profiles are performing better than their peers.”
Larry’s message no doubt applies to the insurance market as well, and based on evidence in 2020, the value of having a robust ESG program means real dollars. Mr. Fink points out in his 2021 letter that, in 2020, 81% of sustainable, globally-representative indexes outperformed their parent benchmarks.
Companies facing increased regulatory and audit pressures to prove ESG credentials
The ESG label is proving to be a lucrative bet for companies and managers, so the unstructured nature of this emerging standard is building a need for proper audits and regulations. According to a recent PwC Survey of 325 investors totaling $14T in AUM, 60% of them do not trust the ESG data coming from scoring frameworks, and the confidence is even less on corporate disclosures. In light of this lack of confidence and increased reliance, both US and European public and private agencies are developing standards to classify, audit, and grade ESG programs at companies.
For insurers, this increased regulatory and audit pressure is very real. For example, the SEC’s Compliance Inspections & Examinations office is prioritizing ESG claims by Registered Investment Advisors (RIAs). In addition, they are in the midst of requesting information from the public on best practices to regulate ESG related disclosures such as climate impact.
Independent agencies such as MSCI and AM Best are developing ways to rank and grade insurers based on ESG pillars. MSCI has developed an ESG rating system to evaluate insurance companies. AM Best is also using ESG factors in their ratings on insurers.
In March 2021, AM Best became a signatory to the United Nations Environment Programme’s (UNEP) FI Principles for Sustainable Insurance (PSI). AM Best states that “management of environmental, social and governance (ESG) efforts will strengthen the insurance industry’s contribution to building a resilient, inclusive and sustainable society”.
The NAIC is also placing focus on ESG initiatives for insurers, having launched a Climate and Resiliency (EX) Task Force. Most recently, the committee met on August 15, 2021 to discuss the latest regulatory changes in relation to ESG. It also heard presentations on how insurance companies, regulators, and rating agencies are adapting to the latest ESG trends. 15 states required the survey in 2021.
The Task Force continues to fine tune the NAIC Climate Risk Disclosure Survey, taking input from stakeholders on the future for the survey. One decision the task force made was to align the framework with what is already in place by the Financial Stability Board’s (FSB) Task Force on Climate-Related Financial Disclosures (TCFD). In addition, it was reported that the SEC has been asked to consider permanent metrics for specific industries, such as banking and insurance.
Challenges ahead for Insurers
These changes are happening fast, so insurers need to ensure they have the agility to keep up. Reporting for ESG is not straightforward, as these pillars require clear framework, solid data, and efficient and accurate processes and reporting.
Stakeholders are demanding solid, investment grade data on ESG, but standards and processes are not fully developed. Insurance will need to be quick to adapt when they are.
The fact that companies will have to combine financial and non-financial data to report their ESG statistics will prove to be costly in itself. In all, there are 4 key challenge areas for insurers:
- What frameworks and models to follow
- Where to get ESG data and how to aggregate and normalize it for reporting
- How to develop the right governance and process to ensure effectiveness and accuracy
- How to produce investment-grade ESG reporting to internal and external stakeholders
How Duco can help
Duco’s platform is uniquely positioned to help with several areas of the ESG movement. ESG is highly dependent on the collection, normalization, and reporting of disparate sources of data to support its three pillars.
The data required for ESG reporting and monitoring will need to come from both financial and non-financial systems – disparate areas of the company. A solution like Duco enables insurers to combine and reconcile these sources to ensure there is a “golden” copy of this ESG data.
This could be reconciling for renewable energy tax credits, marrying investment portfolio data to an ESG data source by CUSIP, or calculating carbon offsets for tax deductions.
With Duco’s solution, insurers can build an audited, centralized source of ESG data. The data can then be exported to BI or analytics reporting tools to achieve institutional-quality reports.
There is a fear among insurers that systems must go through painful integrations or be replaced entirely if they are to fully meet ESG standards. Duco is here to say: one system to rule them all is not the answer. Let’s put trust back into your data and build the golden copies needed to confidently report your ESG metrics back to your stakeholders.
For more information, see our Duco For Insurance solutions page.