The use of environmental, social, and governance (ESG) benchmarking to assess company performance in this area is increasingly popular among investors and insurers alike. But given a lack of regulation around each platforms’ assessment methodologies, they might not always present an accurate or consistent picture. With ESG-related claims on the rise and the trend seemingly set to increase in 2023, firms should go above and beyond to ensure their underwriters have a correct understanding of the business’ activities.
Benchmarking is on the rise
The focus on ESG benchmarks has grown in recent years, as firms across sectors have come under increased pressure to demonstrate progress towards ESG-related goals.
In principle, benchmarks provide an indication of how a company performs against others within their industry. Benchmarking assessments incorporate a combination of publicly available data, alongside questionnaires and data processed by internal analysts, often giving a result in the form of a numerical score.
Of increasing popularity with shareholders and investors, the growth of benchmarking correlates with a rising flow of investment towards responsible funds – which as of March 2023, accounted for £96bn out of the total £1.6tn under management in the UK(opens a new window). These developments have prompted many firms to redesign their business models, with ESG now forming an integral part of their operational and investment strategies, including executive compensation.
Insurers, many of whom are looking to their portfolios with one eye on their own ESG performance, are increasingly making use of the benchmarking tools for their risk assessment, with many incorporating benchmarking the methodology into their underwriting process. The launch of specialised ESG-syndicates by several insurers is also offering exclusive underwriting capacity to firms with best-in-class credentials in this area.
The risk of inaccurate assessments
As emphasis on ESG grows, so does the need for transparent and reliable data that reflects a business’ efforts. However, concern is growing as to the accuracy of benchmarking systems.
A recent warning from the Financial Conduct Authority (FCA)(opens a new window), found that ‘the overall quality of ESG-related disclosures made by benchmark administrators was poor’, and has urged stronger regulation of ratings tools. In particular, the statement noted that typical ESG benchmarks lacked methodological detail, and didn’t explain or make those methodologies accessible to users.
It also found that ESG disclosure requirements were not fully implemented, and that methodologies themselves were not necessarily applied correctly. For example, some benchmarking systems relied upon outdated data, or failed to apply ESG exclusion criteria correctly.
In light of the warnings from the FCA, firms may find their efforts are not fully reflected in their ESG ratings, potentially translating into excessive premium payments, less favourable or even restrictive cover terms for relevant insurance, such as directors’ and officers’ (D&O) liability insurance.
This is particularly true of private firms, where information relating to ESG strategy is less likely to exist within the public domain, and public businesses that are increasingly cautious of publicising their efforts outside of minimum requirements due to a rising number of “greenwashing” allegations.
Limited information in this area increases reliance on ESG benchmarking, reduces underwriters’ understanding of their clients’ risk exposure, which can result in deserving firms falling outside the underwriting appetite of specialised ESG insurers.
Underwriting ESG
When it comes to the provision of cover, underwriters of D&O insurance have historically focused on the governance pillar within ESG. Broadly speaking, this involves assessment of firms’ controls, procedures, and oversight within the business, with good corporate governance positioned at the heart of directors’ responsibilities.
When it comes to the social pillar, focus areas include supply chain assessments, modern slavery controls, community engagement, and being a good corporate citizen.
Most recently, however, it is the environmental pillar that has proved of greatest interest to underwriters. In particular, firms as part of their insurance renewal may find themselves asked to present a range of information about their environmental actions, including but not limited to:
- Environmental disclosures, such as Task Force on Climate-Related Financial Disclosures (TCFD) and CDP, a widely used environmental reporting system.
- Optional milestones to which companies are committed, such as stated targets for net zero
- Internal groups or committees with oversight for the company’s environmental responsibilities
- Engagement of external advisors to guide climate-related reviews and disclosures
- Use of climate-related risk management frameworks, including current and emerging risks
- Awareness of relevant climate-related legislation and understanding of relevant requirements
- Strategies to ensure compliance with climate-related policies
- Board engagement in climate-related risks and opportunities
- Roles with a focus on ESG practices, such as a Chief Sustainability Officer or Head of ESG
- Alignment of third-party suppliers with company guidelines, and continuous monitoring of these partners, including in areas such as modern slavery and climate-related goals
- Involvement in current or past greenwashing allegations or investigations
How should firms prepare for renewal?
With ESG-related claims predicted to increase in 2023(opens a new window), providing accurate underwriting information to secure favourable terms is essential for a successful renewal.
To mitigate against the risk of heightened premium costs at renewal, clients should proactively provide insurers with a package of information detailing the full extent of their ESG efforts. In doing so, underwriters are fully briefed on the relevant risk exposures, reducing reliance on inaccurate benchmarking procedures.
Actions to secure an accurate ESG assessment include:
- Work with your broker to understand sector-specific concerns and address these head-on as part of your renewal submission
- Seek clarity and understanding regarding the research methodologies used by a given underwriter in order to guide preparation
- Host an underwriting call with sustainability colleagues where possible to allow open conversation and give underwriters insight into how consideration for the environment forms part of the company culture
- Coordinate between multiple business units where necessary to develop an accurate assessment of internal ESG performance
- Gather data regarding any existing policies, including relevant analysis – such as key ESG-related issues within the business and strategies in place to resolve them
- Where not obligatory, make voluntary disclosures of core ESG strategy to ensure information is available to underwriters
- Undertake preparatory ESG assessments either internally or through third parties, to identify exposures and develop an in-depth strategy
- Ensure ESG reports or other relevant documents present data with clarity and effectively communicate key takeaways
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Lizzie Harris, Account Executive
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