ESG Will Increasingly Influence Insurers’ Strategies: Fitch Ratings
Environmental, social and governance issues will grow in their influence in insurance industry decision-making as they become more important to stakeholders, according to a report from Fitch Ratings.
For most insurance companies, environmental, social and governance (ESG) factors often are not incorporated into risk-based premium calculations, aside from direct material influence on risk, such as weather-related perils for non-life insurers.
However, that thought process is evolving.
Fitch Ratings’ latest ESG report, “Global Insurance Through an ESG and Sustainability Lens: Influence of ESG on Insurers’ Underwriting and Investment Decisions Will Increase,” predicts ESG-driven decisions will influence insurers’ credit ratings in the medium term as social and regulatory pressures push more insurers to account for ESG considerations.
“We believe that most insurance companies’ decision-making on ESG issues will be steered by risk appetite defined at the governing board and delegated board levels, which will be subject to change over time as internal knowledge and experience grow,” the authors write. “This will include discussion of which ESG issues are most material across the lines of business from either a financial or regulatory/supervisory perspective, or whether stakeholders are raising specific ESG issues that may result in reputational or ethical risks.”
In the longer term, sectors most exposed to ESG-related risks will face more significant challenges as stakeholders demand greater rigor and disclosures, including insurers’ ESG implementation strategy.
Insurers should also see some opportunities for revenue growth.
Global View
Voluntary ESG-related principles, such as the U.N. Principles for Responsible Investment and the U.N. Environmental Programme Principles for Sustainable Insurance, reveal low representation by North America compared with Western Europe, Asia-Pacific and Latin America. This may reflect that the North American investor base as a whole is less concerned about the impact of ESG-related issues than investors in Western Europe and developed-market APAC regions, according to Fitch.
The International Platform on Sustainable Finance (IPSA), a multilateral forum for public authorities, is working to create a common ground taxonomy on central issues, including channeling capital from unsustainable activities. The IPSA’s members include Canada, China, the E.U. and the U.K., but the U.S. has declined to join.
Insurance and Economy
Those insurers more susceptible to stakeholder pressure are more likely to embrace advanced ESG integration approaches, policies and related disclosures. They are also more likely to develop detailed underwriting policies and investment mandates incorporating measures like ESG investment screening and restrictions.
Insurance companies, unlike banks, are hesitant to stop underwriting specific economic sectors, judging instead on a case-by-case basis.
However, this can lead to a conflict of interest between an insurer’s various ESG targets. For example, a life insurance company may decide to stop underwriting coverage for thermal coal mines to meet an environmental goal but, at the same time, risks contributing to a social issue if the move increases local unemployment.
A greater focus on legal and regulatory frameworks to manage environmental and social issues may spur the growth of new ESG-related insurance products and services to address these needs, the report adds.
Fitch sees potential growth in the environmental pollution liability insurance market. Also, the U.S. Inflation Reduction Act’s funding for clean energy and climate change abatement, as well as government-backed research into low-carbon technologies, will create opportunities for new insurance policies and products. Also, there is increasing demand for more parametric or index-based cover, particularly for weather-related events, Fitch notes.
Environmental Catastrophes
Climate change contributes to more frequent and more intense weather events around the globe.
Cumulative losses from floods rank among the highest of natural perils — more than 50 severe floods occurred worldwide in 2021, including the costliest in Europe’s history. According to Swiss Re, the combined economic losses from all flood events in 2021 rose to $82 billion.
Today, the U.S. is an epicenter of catastrophe-related insurance claims. However, as insurance product penetration increases in those areas, Latin American and Asian markets with relatively higher catastrophic exposure will see more climate change-related financial impacts.
Societal
Less attention has been paid to social issues within the financial services and insurance sectors, leading to a lack of standardized guidelines or benchmarks. This ambiguity makes it challenging for investors to compare insurers’ social agendas. Basically, a company’s social justice or equity responsibility claims can sound good but be unquantifiable, according to the Fitch analysis.
Insurers have responded by carefully realigning sellers’ (or agents’) incentives with better customer outcomes, reinterpreting conduct risks to identify material risks, and improving their complaints handling processes, the report finds.
Governance
Of the ESG elements, governance has the most significant overlap with Fitch’s core credit rating criteria. Corporate governance, management strategy and financial transparency are essential considerations in Fitch’s credit rating process.
However, the insurance sector’s credit ratings have been less influenced by governance or conduct issues than credit ratings for banks and non-bank financial institutions. Insurers have fewer negative rating actions linked to governance issues or risks but more risks tied to environmental issues.
As long as guidelines around reporting and disclosing ESG issues remain ill-defined, companies can misrepresent information to green or social “wash” activities. Even if this misrepresentation is unintentional, companies may need to convince investors and other stakeholders that they meet ESG requirements.
A global movement toward regulation and benchmarking will mean insurers have greater quantifiable accountability to investors, stakeholders and the insured.