The insurance industry and ESG: challenges and opportunities

In terms of liabilities, it is enormously exposed to the extreme weather events that are becoming more commonplace through the crisis, while also holding a responsibility to help its clients to recover with the right kind of insurance in place. At the same time, the insurance industry has the ability to make a significant contribution to tackling climate change and wider environmental, social and governance (ESG) challenges via sustainable investing. In the UK alone, it is estimated that GBP0.9 trillion could potentially be made available between now and 2035 to invest in meeting net-zero targets¹.

Both insurance and reinsurance firms around the world have an important part to play in driving meaningful change – and providing the tools to help others. In 2021, the European Insurance and Occupational Pensions Authority (EIOPA) published an opinion setting out expectations on the supervision of the integration of climate change risk scenarios in Own Risk and Solvency Assessments for the industry². According to EIOPA guidance, climate change transition risks are related to the change to a low carbon and climate-resilient economy and can include policy, legal and reputational risks, whereas physical risks are related to the physical effects of climate change such as weather related risks and longer-term temperature changes. A more detailed definition of these risks can be found in section 3.6 of the EIOPA document³. In all cases, risk management is core to an insurers role and assessing physical and transitional risks is an everyday task in the industry. For this reason, underwriters have been using advanced weather forecasting and detection technologies for decades and could help advise policymakers, nations and individual companies on how to mitigate for the climate crisis.

Clearer analysis of risk is highly necessary, as there is a “protection gap” across the world in how much is insured against climate change versus the cost of extreme weather events. According to Aon, nearly 400 natural catastrophe events in 2018 generated economic losses of USD225 billion, yet only USD90 billion was insured⁴. In 2020, the gap between the economic costs of natural disasters and the value of assets covered by insurance was similar, but compounded by the effects of the global pandemic. Economic losses from natural disasters alone were USD268 billion, but insured losses were only USD97 billion, a global protection gap of 64 per cent⁵.

While insurers are facing the challenges of covering risk in a changing world, they are also under pressure from stakeholders such as employees, investors and regulators to respond to the climate crisis. A number of regulations are being introduced that will impact the corporate disclosures that insurers will be required to make, for example, in the EU, under the Corporate Sustainability Reporting Directive (CSRD), companies will have to report on the process by which they have identified and assessed the adverse impact they have on the environment and society, and the most significant sustainability risks that could impact their whole value chain⁶. In Asia, the Hong Kong Exchange has also consulted on proposed enhancements to the Corporate Governance Code and related listing rules on board independence, diversity and ESG reporting⁷.

Insurers need to review their own corporate governance to ensure that they are embracing sustainability in their business and a number of insurers have set out net-zero targets⁸. But they are also analysing how they can effectively and efficiently incorporate sustainability into their investment strategies. Shareholders, and the wider industry, now expect firms to have a good framework in place around ESG goals.

However, implementing a strong framework is no easy task. Regulators may stipulate more ESG reporting and shareholders can demand investments that meet their principles, but it’s not easy to gather and analyse the data when reporting and metrics are still fluid and fractured. The process of defining and creating ESG metrics from what is often predominantly research opinions can create as much confusion as clarity, as we have outlined before⁹. A key challenge is to find transparent, credible and valid ESG data and gather it into an efficient platform that enables efficient and meaningful metrics to evidence ESG outcomes, for example carbon reduction targets and physical climate risk factors.

A significant issue is data consistency. Despite emerging efforts from regulators and independent bodies to institute standards – such as the Task Force on Climate-Related Financial Disclosures (TCFD) framework –ESG information is often open to interpretation. Indeed, within climate risk, there’s open questions on what is considered environmentally friendly. How should carbon offsetting and carbon capture be counted in relation to carbon reduction, for example? Is nuclear energy “green”? This nuclear energy example has been the subject of much debate for the EU Taxonomy to accelerate decarbonisation and under strict conditions it now proposes that certain gas and nuclear activities to be considered as “environmentally sustainable”.¹⁰

There are also transitioning companies, those who may score highly on one element of ESG, while scoring poorly on another level. A solar firm is obviously enabling new green energy sources, but what if its board lacks diversity and it sources its components from factories with questionable labour practices? Insurers are struggling not only with inconsistent definitions and standards in the data, but also data that stretches across many types of E, S and G factors that can have patchy coverage and data gaps.

Data accessibility can also be a problem. While some insurers manage their own investments, many outsource to multiple asset managers, each of whom will apply their own methodology in assessing sustainability. This can lead to the insurer receiving inconsistent information across their overall assets unless they source information and measure ESG independently across their invested assets.

For many insurers, the answer will be in seeking data provision services incorporating independent ESG and climate data. These services will bring together accounting data with third-party ESG data and aggregate it into a digestible and accessible form as well as periodic data feeds that makes it flexible, scalable and targeted to the insurer’s needs.

The impact of ESG on the insurance industry is broad and multi-faceted, with pressure from clients, regulators, shareholders and wider society. Insurers need to address ESG internally, support clients in covering climate risk and apply ESG standards in their own investments. But this important role in addressing the climate crisis also offers opportunities. With the right response, insurance firms can be part of the solution in financing the transition as well as providing protection to customers against climate risk, helping companies and the wider world to mitigate for and adapt to a changing world and deliver on commitments for a sustainable future.