More negative than positive insurer ESG rating actions: AM Best

Weather-related events and governance were the two biggest drivers for environmental, social, and governance (ESG) ratings actions on insurers between April 2020 and March 2021, according to a new report from AM Best.

AM Best disclosed its ESG ratings actions as part of recent regulatory requirements on credit rating agencies issued by the European Securities and Markets Authority. When ESG factors drive positive or negative rating actions, AM Best must disclose whether ESG was a key driver of the change. For example, an insurer that experiences weather losses beyond their expectations and risk appetite might see a negative action, while a company that exceeds expectations and improves its governance might experience positive ratings actions.

Between April 2020 and March 2021, AM Best made 47 ESG-related ratings actions, of which 31 were negative and 16 were positive. ESG was a key factor in 13% of AM Best’s global rating actions during the period. Some 10% of all ratings actions were driven by ESG factors, while 16% of the negative ratings actions were driven by ESG factors.

Property and casualty insurers accounted for 85% of the rating actions driven primarily by ESG factors, and life/health 15%. Almost three quarters of the ESG-driven rating actions were for insurers domiciled in the US, with 15% in Europe and 13% in Asia-Pacific.

The vast majority of positive ratings actions were either related to weather or governance. Governance drove 69% of positive ratings actions while weather was behind 31%. Weather actions were typically the result of insurers strengthening their operating structures and better controlling exposures to weather-related events. In most cases, governance actions were directly linked to improvements in insurers’ ERM building block assessments.

Weather and governance were also the most common drivers for negative ratings actions, followed by reputational risk and other environmental factors. Weather was the main contributor to negative ratings actions in 36% of cases, and contributed to a further 9%. Governance accounted for 43% of ratings actions, and reputation and other environmental just 6% for each.

“The vast majority of ratings actions for which weather was the driver were due to weather-related events for which exposures fell outside of expectations. This was particularly true for small monoline insurers with geographical concentrations, such as companies exposed to floods or wildfire risk in a single US state,” AM Best states in the report.

Failure to manage catastrophe risk may also be a consequence of weak governance, the ratings agent adds. “Themes related to governance include issues related to the continuous strengthening of reserves over time, an inability to manage regulatory solvency requirements, and irregularities in financial statements,” it explains.

Material ESG factors can impact the creditworthiness of an insurer and affect the financial strength, performance and reputation of a company, according to Mahesh Mistry, senior director at AM Best. “Environmental factors are considered a severe threat to balance sheet strength and operating performance of some insurers due to the potentially significant, rapid and unexpected impact of weather-related losses,” he says.

The ratings agency generally classifies weather-related events such as hurricanes, cyclones, wildfires, droughts, storms and floods as events affected by climate risk, explains Mr Mistry. “AM Best expects insurers accepting weather-related risk to demonstrate that they can effectively manage them – including the impact of changing climate trends – and have the financial wherewithal to absorb associated potential losses,” he says.

AM Best also considers social factors in its ESG ratings methodology. This focuses primarily on changes in social behaviour and demographics, which offer both challenges and opportunities for insurers, according to Mr Mistry.

“Insurers that are attuned to customer needs, are innovative and have access to data will be more successful in defending their market position. Alternatively, an insurer’s business profile may be negatively affected following an ESG-related scandal such as a data breach, which has the potential to materially damage the company’s reputation and brand. Such an incident could have repercussions on the company’s ability to generate new business and retain existing customers,” he says.

Governance factors are also explicitly considered under the ERM building block for both financial and non-financial factors. “Ensuring a (re)insurer has a viable business model is critical to the longevity of an organisation. Hence, navigating changing market conditions and the regulatory landscape on ESG is important,” explains Mr Mistry.

“(Re)insurers may be affected differently, subject to the markets they operate in and the products they offer. Many see transitioning to a low-carbon economy as important, and thereby are considering how to adapt their strategy and collaboration with partners to meet strategic objectives. ESG should be seen as a risk and an opportunity for (re)insurers,” he says.

ESG factors have been a part of AM Best’s Credit Rating Methodology for many years, and were updated in 2020 to reflect the latest developments. However, insurance markets are at different stages of acceptance on ESG, so the impact on insurers and reinsurers can be varied, according to Ghislain Le Cam, director of analytics at AM Best. “There has been a concerted push from stakeholders, including governments, regulators, shareholders, ratings agencies and other industry bodies to promote and embed ESG principles into operations,” he says.

Regulatory requirements on ESG continue to evolve, with many jurisdictions in the near term requiring (re)insurers to disclose ESG information in financial statements, says Mr Le Cam. At present there is no standard practice and insurers are left to make their own decision on disclosures. However, there are a number of forums looking to improve consistency of disclosure, such as the Financial Stability Board (TCFD), the IFRS Foundation and the IAIS, among others.

“While the initial push for ESG considerations is predominantly in Europe, notably supported by rising regulatory requirements, there have also been significant developments in Asia, the United States and Canada. Even emerging economies in Africa, the Middle East and Latin America are incorporating ESG into their agenda. The COP26 is likely to gain further traction and commitment on ESG,” adds Mr Le Cam.

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