The evolving ESG risk landscape

The latest report in our ‘Risk & Resilience’ series shines a light on environmental risk – environmental liability, climate change, energy transition, pandemic and food security. This is the most rapidly evolving category of risk, yet one that appears to be a blindspot for businesses, with only 12% ranking this area of risk a top concern.

The recent COP26 summit set some very clear priorities for governments, businesses and individuals, and the insurance industry can play a key role in helping deliver those priorities and in helping businesses to better manage the new, emerging environmental risk landscape.

ESG concerns dominate
The rising pressure on companies to provide guidance about their environmental, social and governance (ESG) credentials is both an opportunity and a risk. On the one hand, it clarifies what is expected of companies. On the other, it poses the risk that businesses, in their haste to comply with new regulations, exaggerate their green credentials or release inaccurate, misleading or misstated information, which could in turn result in shareholder or derivative suits. Activists and regulators alike are intensifying scrutiny on how companies disclose exposure to fossil fuels and their ESG reporting.

Companies need to ask themselves searching questions about how their business is dealing with a range of environmental concerns. The insurance industry also needs to ask questions about how companies are monitoring and managing risk in these areas, and this will become part of every D&O renewal meeting discussion.

Already, there have been claims where a business has suggested that a product or production process is greener than it really is. The more public opinion pushes for greener, more environmentally-friendly products, the more companies want to be seen to be ESG-friendly – and the more likely they are to overestimate their capabilities.

How should the insurance industry respond?
Underwriting models are being challenged. New hazards will emerge as the transition to a greener economy takes place, requiring new products and new underwriting solutions. The challenges in shifting to clean fuels, such as hydrogen, are significant. Losses on offshore wind and on large solar plants have been substantial for example – green assets are just as exposed to catastrophe risk as traditional energy assets, possibly even more so.

Traditional modelling, particularly around natural catastrophe exposures and, more broadly, past loss experience, have not been predictive of the future and that will need to be corrected. This will require coupling a deep knowledge of the risk landscape with technology advancements to map a better future. Much work still remains to be done to create a common framework for evaluating the strength of businesses’ green credentials.

Green shoots of progress
However, progress is underway through moves like the Sustainable Markets Initiative and ClimateWise initiatives. It is also hoped that policies announced at COP26 will have a marked impact, including particularly the creation of the new International Sustainability Standards Board, which is introducing new prototype global standards on climate-related disclosures and general sustainability disclosure requirements.

Initiatives like these are sparking a huge amount of collaboration across the insurance industry to create common methodologies and appraisal mechanisms. The issue as always, however, will be the quality and availability of the data needed to support informed decisions and how the industry implements new approaches, so as not to destabilise communities dependent on particular energy sources for employment and power.

Aligning business and social agendas
Driving better alignment between business and social agendas is a complex challenge that requires long-term solutions and dedication. A key factor in that success will be working together to forge stronger, deeper relationships and clear prioritisation to invest in a strategic roadmap, creating a more sustainable planet for all.

Delivering on these objectives will require more breakthrough innovation in this space, greater collaboration around standard-setting and regulation, and a heightened sense of urgency to deliver real solutions. The link between ESG credentials and loss ratios is beginning to be established and access to more high-quality data is improving. Progressive solutions to problems as complex and wide-ranging as these that speed up energy transition, and which respond to the realities of climate change, will not be developed overnight nor in response to unrealistic demands, but through market alignment, collaboration and further sharing of data.

We recognise there are huge challenges for the insurance industry as we support our clients through their transition to a low-carbon economy, and how we factor this into our underwriting decisions. We are also keen to be able to identify which businesses are performing well from an ESG perspective and to have open discussions with them, and to encourage and support as many companies as possible to improve their ESG performance as the world transitions to a net-zero future.

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