ESG Special: Planning and implementing an effective ESG strategy

But generally, we often hear insurers ask how they can design an ESG strategy and align that with their overall business goals, as well as incorporating ESG factors into their business strategies, into wider risk management frameworks, into investment portfolios, et cetera.

Niamh, you're a deputy divisional lead for our life insurance business in the UK and Ireland. And in addition, you focus on bringing risk and ESG solutions to life insurance clients.

Mike, you have more a background in strategy, risk management, governance. More recently, this has included an increased focus on insurers and how they can incorporate ESG considerations into their strategies and frameworks, and decision-making, and how they can respond to climate changes in their portfolios.

So our focus today will be on developing and implementing an ESG strategy, and including identifying issues and outlining practical steps for getting started. That's the aim.

Before we get into that discussion, first let's find out a little bit about our guests. So Mike, there's a former professional basketball player called Mike Wilkinson. He's American, but he played for the Macedonian National Basketball team. I'm assuming this isn't you, and basketball isn't one of your big secret hobbies?

MIKE WILKINSON: You've got it right. Absolutely, something a bit more sedate I think. One of my interests is that I'm quite an avid collector, probably too avid as I get quite a lot of clutter, and I'm also quite eclectic.

But one thing I do find fascinating is antiques, old, relatively mundane artifacts. But somehow, they've survived and provide a real connection to old civilizations and their worlds, including the social structures and the challenges they faced. It's also quite sobering that some of these civilizations have disappeared through an environmental cause of whether it's a catastrophe or something over a longer period, which I think is quite a lesson in sustainability.

SINA THIEME: OK, so that actually quite nicely links to what we're talking about today. Well done. Niamh, your namesake does brain research in Germany, I found. And another one is a designer in Manchester. Are these the sorts of results you wish one would find when Googling your name, and I guess are these related to your own hobbies as well?

NIAMH CARR: Well, yeah. I mean, it would be great to be known for either of those things. But unfortunately, I don't have a lot of time for hobbies at the moment, I've got two young sons. But I do really enjoy traveling and experience new cultures. And my older son is on the eco committee at school. And while we were arranging a holiday recently, he was very conscious of avoiding flying, so we're going to visit the Netherlands by road and rail for our next trip and we're really looking forward to it.

SINA THIEME: Brilliant. It really seems like you can't turn on the news these days without hearing something with regards to climate risk or social concerns. COP28 was obviously just on. More recently, we've seen a number of regulations reflecting ESG requirements. Niamh, maybe you can just start and talk about the current environment that insurers are operating in.

NIAMH CARR: So overall, insurers are operating in quite a challenging market at the moment with inflationary pressures, interest rates increasing, as well as regulatory changes, including IFRS 17, but ESG is also clearly on the agenda for many insurers at present. The need for an ESG strategy has partially been driven by regulatory requirements with a proliferation of new regulations, but also to a significant extent due to pressure from wider stakeholders, investors, rating agencies, and more and more customers wanting to make sustainable choices.

And in addition, we've seen that employees want to be confident in the sustainability credentials of their employer. So a lot of the focus to date has been on the environmental side, in particular, on climate. And here, if you think about it, changes are happening very, very quickly where climate science and data is evolving at the speed of light.

So if you think about it, the Paris Agreement to pursue efforts to limit the temperature increase to 1.5c was ratified less than a decade ago, in November 2016, which actually we may already have failed at, given that the recent Emissions Gap report from the UN highlighted we're on course for a 2.5 to 3 degrees warming.

So since 2016, we've seen significant legislative, regulatory, and organizational developments. The Financial Stability Board Task Force on Climate-Related Financial Disclosures, also known as TCFD, their reporting recommendations were originally published in 2017 on a purely voluntary basis but they've subsequently become a regulatory requirement in some jurisdictions.

And we've seen recently that the COP28 deal has for the first time, included reference to the transition away from fossil fuels, as well as more commitment on emissions other than CO2. So insurers need to consider the potential impact of this on their business.

However, we're also seeing a greater interest in wider environmental aspects such as nature and biodiversity. So this is thinking about how changes in ecosystems and biodiversity have knock-on impacts. For example, the reduced number of pollinators impact on food supply. So there's now a task force for nature-related financial disclosures as well as the TCFD, with the aims of developing and delivering a risk management and disclosure framework for organizations to report and act on evolving nature-related risks, with the ultimate aim supporting a shift in global financial flows away from nature negative outcomes and towards nature positive outcomes.

And in addition, many insurers are now thinking more about the S, the societal aspects, and the G, governance aspects. In particular, around inclusion, diversity, and equity, and also the societal need for insurance. Trends in this social space, as well as the impacts of inflation and cost of living for both employees and customers, is making these aspects more prominent. So an ESG must take all of this fast-evolving landscape into consideration.

MIKE WILKINSON: Thanks, Niamh. I think just to add to that, there's a lack of consistency, which increases the challenge for insurers. So first of all, throughout the whole of the ESG landscape, there are multiple initiatives, multiple frameworks, and standards. Many of which are evolving over time. They've got different scopes, got different objectives. And even though there are some common themes with all of these, they're each evolving in their own way. And just keeping up to date with all of those, particularly, if you work on an international basis, is actually more than a full-time job. For example, we're maintaining a database.

Some of the standards focus solely on climate, such as TCFD, which you mentioned earlier, whereas others, such as the European Union's Corporate Sustainability Reporting Directive or CSRD, covers the whole of ESG. So if we consider ESG as a whole, the different aspects of this can't be considered as silos, where it's the people side, or the environmental, or ecosystem side, or on governance. Many of these are interconnected. So if you're looking at one aspect you might actually have a detrimental impact on one of the other aspects.

Regulations like the CSRD aim to take this into account, for instance, through double materiality, which means considering not only how climate or ESG risks impact the company like TCFD does but also how the company impacts the environment and society across different aspects of ESG. So insurers should be mindful of the trade-offs between different aspects of ESG in their strategies and how they prioritize all of those.

SINA THIEME: Yeah, Mike, and I guess you mentioned the lack of consistency there, and that's partially driven by regional differences in ESG regulations. Maybe you can expand a bit on that.

MIKE WILKINSON: OK, well thinking about regulations specifically, we're in quite a transitional period in this respect, I think. And it's fair to say that a number of existing reporting frameworks and standards have so far been on a voluntary basis but the emerging regulatory standards will be mandatory, at least for the companies in scope, and this should, at least in theory, reduce the risk of greenwashing.

Now, many insurance and other financial regulators across the world have published their own regulations or in consulting on them. So in larger markets, such as the UK and in SEC in the US, to more specialist markets such as Bermuda or Singapore, and many others in between.

While the regulators have common themes and approaches, as you'd expect, some such as the SEC are largely principles-based, and some are on a best-efforts basis, at least in the initial phases, to give insurers a transitional period to adapt to the regulatory framework fully and adapt their businesses where appropriate.

So given this, some of the more global or regional initiatives of wider insurance, such as the IFRS sustainability disclosure standards and the EU's CSRD, will also have an impact depending on the company's locations. So for multinational players, this can add to the already complex world of managing multiple regulatory environments. Although for instance, the EU has flagged they will be introducing an equivalence regime, like it has for Solvency II, although that's unclear at this point.

NIAMH CARR: And what we've seen is that the Americas are lagging a bit compared to the UK and Europe in general, with some backlash in particular in the US market against climate change requirements. But having said that, we have seen some recent momentum with new requirements. So in Canada, in Bermuda, and also in the US, with states like New York, California, and Connecticut pushing forward some regulations with regard to climate-related risks, and also we've seen developments in Mexico, and Brazil, and Latin America.

But at the same time, the climate regulations emerging from the American jurisdictions are really actually quite similar to what we've seen in Europe and the UK, which are fairly inspired by TCFD recommendations, including a focus on governance, strategy, risk management, and obviously, disclosure.

SINA THIEME: Niamh, I guess apart from compliance with regulation, could you talk a bit more broadly about why it's important to have an ESG strategy?

NIAMH CARR: So I think that this depends on the motivations of the insurance company. In recent times, many insurers have gone back to considering their purpose, i.e., why they exist. And as a result, many want to go beyond a regulatory box-checking exercise and link back to their purpose. And this helps them to clearly define their ESG strategy. It helps them to decide where they should focus and how to allocate resources.

A clearly defined and embedded strategy will ensure that insurer clearly understands the potential risks and exposures arising. So for example, from climate, and can seek to mitigate such risks where possible. An insurer may also be able to identify opportunities to create value through their ESG strategy, for example, seeking to find new customers through providing health insurance, which incentivizes preventative measures such as exercise, and this can be a win-win for both the insurer and the policyholder.

An ESG strategy does need to be tailored. For example, a life insurer with a long-term focus will need to consider longer-term aspects such as will the assets backing liabilities suffer through climate transition risk. Whereas an insurer providing liability coverage to energy companies will have a different area of focus, such as the risk of greenwashing.

MIKE WILKINSON: And if we look at the question another way, there are some clear risks of not having a well-developed and communicated strategy. So if the company's approach is driven only by regulatory and reporting needs, not only will those change over time and won't necessarily be geared towards the firm's specific profile, but there's an increased exposure to reputational or litigation risk as the insurer won't be able to be sure that it's not saying one thing and doing another.

Equally, unless you have clearly articulated and communicated principles and priorities, how would you manage trade-offs between different priorities, where an action that might seem positive on one aspect of ESG could have a detrimental impact on another? So a typical example of this might be insuring lithium mines, which are important to the transition away from fossil fuels, can also involve environmental degradation, human rights concerns, et cetera.

So it's important that the strategy covers all aspects of ESG, including the priorities between different aspects and how these will be managed or governed in the day-to-day operations of the company, including how this is integrated in the firm's risk management framework as well.

For insurers, it's particularly important that not only does it cover the company's internal activities and value chain but also focuses specifically on the insurance and investment portfolios, as Niamh has indicated earlier. So for instance, a company might wish to implement a consistent decision-making framework covering both risks and opportunities. Something like this can help with understanding how to manage both priorities and the trade-offs based on how material different risks are, to enable it to navigate a coherent and consistent path over the longer term and adapt to changing circumstances.

It can also help to provide clear justification of the company's actions to both internal and external stakeholders to reduce inadvertent reputational risks. And as Niamh said earlier, this does need to be aligned to the firm's purpose, as well as commercial realities and operations to be both effective and embedded.

SINA THIEME: Very interesting, Mike. What are some of the other considerations when a company is trying to develop an ESG strategy?

MIKE WILKINSON: Well, I think you can look at this in a number of ways, you can look at the top-down, or bottom-up, or preferably both. Because one of the things you can do to start being clear about what you're talking about, having clarity of terminology. We've seen organizations set up quite ambitious statements which are very high level and can be seen as quite vague.

However, the strategy needs to be much more specific, turning these high-level statements into something more meaningful in terms of what a company will do to achieve their ambitions in practice. These, in turn, need to be translated in how they impact day-to-day operations and how these are governed and monitored.

This part can be much more difficult as principles may be implemented differently in different parts of the organization. They may be context-dependent, perhaps through operating in different territories, or markets, or considering the materiality of the risks and commercial realities. The potential or perceived lack of consistency will need to be capable of being explained and communicated to stakeholders.

And given that ESG, and particularly climate, is very fast-moving and needs to be viewed over a long time horizon, the strategy should be adaptable and agile to be able to respond to changing circumstances. So having clear governance, risk management, decision-making, and communication in place. Having a well-developed scenario framework to support this will also be a critical element, particularly as agreed time frames for actions on climate change are still quite unclear, even after COP28.

NIAMH CARR: Yeah, Mike, I really agree with those points. And I think another point to add is the importance of alignment from the top down. So especially at the board and the management level, there needs to be a common understanding of what ESG is for the organization, what's important to the company, what's meaningful, what's material, and what's the purpose of the organization. And then they can start to build a strategy.

SINA THIEME: So I'm also curious about the flip side. Niamh, what are potential issues for insurers that

don't act?

NIAMH CARR: So as we spoke about quite a lot earlier, there are increasing regulatory requirements. So a company needs to ensure they're keeping up with those requirements. And in particular, have enough time to build capabilities to meet those requirements. And regulators have put a lot of focus on this.

But personally, I think there's a really large reputational risk. As I mentioned earlier, from what we're seeing in the market, it's really become necessary to have an ESG strategy because stakeholders, including investors, customers, and employees are all expecting insurers to have one. They want to see a clear and tangible ESG strategy.

Those insurers that don't have one will fall behind and potentially be subject to negative press and social media commentary. And where an insurer does have a strategy, it needs to be credible. A strategy that isn't credible opens an insurer up to allegations of greenwashing.

MIKE WILKINSON: Some of the other potential issues are kind of data in particular. So data is critical to the understanding of what's in the portfolios, what's your own footprint around ESG, et cetera. And essentially, whilst it's possible to acquire data from external sources, and there are a number of providers who do provide this sort of data, it's important to build your own body of data aligned to specific businesses and particularly around how the company will make decisions.

So for instance, external sources may provide data which doesn't have the level of granularity that helps you to make business decisions. And building that internal data takes time, and actually, until a company starts doing it they're not going to necessarily know exactly what data A, is available, and B, is needed.

So those sort of things are important because effectively, the company may never catch up if others are already doing this and will be disadvantaged on that basis.

And if we just think about climate for a moment, a specific part of ESG, clearly, emissions data is very important and actually needs to be reported but more important is how you manage through that transition. And understanding transition plans from firms that you're underwriting or you're investing in can be a really important part of it. So unless the company has a strategy to understand how it's going to be positioned around managing the transition and the extent to which it wishes to influence the transition of the companies that it's involved in, then it's going to be very difficult to do.

Another challenge, not having a strategy, is really the risk of not being in control of your own destiny. For instance, the company may be driven by regulation or externally set targets without due consideration of its own roadmap. It might miss opportunities to test and learn in the fast-moving environment to be able to understand and test different strategy, or different parts of strategies and adapt these over time, or simply risk being unprepared for risks that emerge in a shorter time frame than expected. And we've already seen that 2023 has been the hottest year on record.

There are also potentially shorter-term opportunities to also be missed. For example, new opportunities such as parametric insurance or potential impact of loss and damage agreements at COP28, or investment in green technology firms, given the aim to triple renewables by 2030.

SINA THIEME: So implementing an ESG strategy really is a company-wide undertaking, right? And there seem to be many dependencies. So Mike, where should insurers start?

MIKE WILKINSON: OK, so that's interesting. We've seen insurers start in different places for this, while some might start by developing an overarching ESG strategy, some also might start from reporting or the regulatory perspective. For instance, some insurers started by looking at TCFD requirements as the start point. Others might begin by looking at part of their business, such as their portfolio of underwriting risks or investments.

And if you think about P&C insurance for example, their portfolio of underwriting risks will be a key driver of the strategy, which could be used as a start point to evolve the overall ESG strategy. So while organizations do tend to start in different ways, wherever a company starts, it's important they don't lose sight of the need for coherence into an overarching strategy. And priorities are going to be different for every company which may depend on their own stakeholders, the business model, target markets, regulatory environment, et cetera.

But key to all of this is to have the clearly articulated view on the ESG drivers that are material to the company's strategy, together with an assessment of those risks specific to the business profile and strategic plans.

A key tool that can help with that is scenario analysis of the external environment, using different assumptions of actions and reactions and taking into account political, social, and economic factors, as well as the company's own stakeholder groups. Another essential activity is to carry out a detailed risk and opportunity assessment of the company's underwriting and investment portfolios in relation to those scenarios and considering both the short and the longer terms.

NIAMH CARR: So again, Mike, I couldn't agree more with what you just said, but just thinking about taking a step back and talking about what I've seen as an effective immediate first step, and I think this is starting with governance. So from what I've seen, those companies that have been successful in building, developing, and implementing an ESG strategy have started with governance.

This means at the outset identifying a sponsor for the ESG strategy. For example, the CEO, and also someone in an existing role that will be in charge of implementing the ESG strategy. And in many cases, we've seen that this is the CRO, or occasionally, a chief sustainability officer. Then, both of them need to make sure that this topic is on the standing agenda of board meetings and subcommittee meetings at a minimum, as well as on the agenda of management committees.

We spoke a bit about alignment earlier, so this is so important to make sure that everybody is speaking the same language within the company's leadership. What we're seeing now for companies for a good ESG governance is already in place, that they're now taking the next important step to make sure that the strategy becomes embedded across the organization and that each business function is clear on what the strategy means for them.

I think the other thing that I would add here is that it's important that this is seen as continuous improvement. And this is really key. So whether we're taking it from a regulatory perspective or from a strategic perspective, there's no company that's got this all figured out already, it's really a long-term journey, and there's going to be challenges and roadblocks that companies will need to overcome. So companies need to make sure that they're taking continuous steps and making progress along the way.

And finally, communication is key. It's so important to communicate the strategy clearly but also the steps that are being taken to implement it so that stakeholders can be confident that they're working on it and that they're going to get there, they're going to achieve their goals with regard to the ESG strategy.

SINA THIEME: Those are great summarizing words. Niamh, Mike, thank you so much for your time and your thoughts.

NIAMH CARR: Thank you for having us, Sina.

MIKE WILKINSON: Thanks, Sina. It's been great to talk about this amazing subject.

SINA THIEME: Thank you to our listeners as well for joining this episode. And if you found this interesting, then please join us on other episodes of (Re)thinking Insurance.

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