Why insurers need to integrate ESG
Today, financial players are hungrier than ever to understand the relationship between ESG (Environmental, Social and Governance) factors and entities’ improved performance.
Greatly affected by environmental changes, the insurance industry is no exception.
As the largest institutional investor group in Europe — and operating within long investment horizons — insurance companies play a major role in financing the move to a low-carbon economy. Just like risk managers, insurers are central to identifying and measuring material climate risks. To remain competitive, therefore, they need to adapt and innovate while factoring these risks into their strategic decision-making process.
ESG is not new to the insurance industry
Let’s pinpoint a common challenge facing all players when it comes to implementing ESG-related strategies: the lack of standards and definitions. As a result, extensive work has taken place to provide various industries with a clear framework.
Back in 2012, the UN Environment’s Finance Initiative developed a framework for the insurance industry, supported by the UN Secretary-General and various industry CEOs: the principles for sustainable insurance. Their purpose? To help insurance players manage sustainability risks while seizing opportunities, as well as move towards a more climate-resilient economy.
What are the four principles?
- We will embed ESG issues that are relevant to our insurance business into our decision-making process
- We will work with our clients and business partners to raise awareness of ESG issues, manage risk and develop solutions
- We will work with governments, regulators and other key stakeholders to promote widespread action across our society on ESG issues
- We will demonstrate accountability and transparency in regularly disclosing publicly our progress in implementing the principles
ESG is becoming more robust with the development of ESG methodologies and frameworks
Credit rating agencies started incorporating ESG factors into their ratings to better evaluate companies’ risk of default. As a result, they have identified high exposure and extensive vulnerabilities in the insurance sector, and are urging insurers to consider a large range of ESG issues to meet their financial objectives. Furthermore, given insurers’ broad asset range of portfolios, there is a high chance that their value would dramatically decrease due to climate change. And let’s not forget that insurers oversee around 25 per cent of worldwide assets.
In February 2019, PSI and Allianz launched the first guide to managing sustainability risks in insurance underwriting. Its overall goal is to aid the ESG due diligence process for clients and transactions. It also provides guidance on developing approaches that integrate ESG risk considerations into the core business and related decision-making process.
In the background, stakeholders may be willing to understand the key aspects of ESG issues so they can assess the relevance of selected approaches. Applicable international standards and best practice frameworks will help insurance industry players identify the elements required to build their ESG strategy.
Regulating insurance players — accelerating the transition
On the regulatory front, the insurance industry must keep a close eye on the EU’s 2018 action plan for financing sustainable growth as well as its related legislative package.
It includes two pieces of regulation that will impact the sector:
- European Parliament and Council regulation on disclosures relating to sustainable investments and sustainability risks, foreseeing the following:
- An insurance undertaking which makes available an IBIP (i.e. which sells an insurance-based investment product) targeting sustainable investments is required to publish information related to these products and its benchmark, if any, on pre-contractual disclosures, websites and periodical reports
- An insurance undertaking which makes available an IBIP must make a sustainability risk policy readily available and include a description of how sustainability risks are integrated into pre-contractual disclosures.
- In April 2019, the European Insurance and Occupational Pensions Authority (EIOPA) published technical advice on the integration of sustainability risks and factors in the delegated acts under Solvency II and IDD. The amendment is predicted to impact these three major areas:
- Incorporation of ESG-related preference information of policyholders and other beneficiaries into undertakings’ suitability assessments, investment strategy and global decision-making processes
- Integration of sustainability risks within the prudent person principle
- Integration of sustainability risks into risk management areas
The bottom line? To gain competitive market edge and stay ahead, insurance players must get ready for current and future regulations, all the while factoring in investors’ increasing demand for sustainable products.