Why intermediaries need to work on ESG
Broking business March 2022
Regardless of their ownership or prevailing jurisdictional requirements, ESG and associated reporting should be a key focus of intermediaries. We explore why this is and identify some of the opportunities for businesses investing in this area.
The concept of sustainability is evolving and expectations on all businesses are increasing. For company directors to act in the long-term interests of all their stakeholders has long been a requirement of UK company law. But it is only relatively recently that government and regulatory bodies in the UK have been asking companies to think about more than just short-term, bottom line profit.
There’s a great deal of information (not to mention a confusingly large number of acronyms) out there in relation to ‘sustainability’ in the corporate world. But the broader factors that companies are increasingly being asked to consider are most commonly referred to as ‘ESG’: the environmental, social and governance issues that might impact upon the financial performance of their business.
It’s important to emphasise that ESG reporting is not just about climate change, even though it is the most advanced area of ESG. That’s because there are already regulatory requirements for certain types of business in the UK to disclose information about the impact of the changing climate on their business, as well as their business’ impact on the changing climate. But formal reporting standards in relation to broader sustainability factors are also coming down the road.
Only the very largest insurance intermediaries in the UK will currently be caught by the climate change reporting requirements. But ESG reporting, in particular for the broader insurance market, is a topic which all intermediaries need to be considering. Here’s why.
Your business’ impact on the outside world
When tendering for new contracts as a provider of professional services, PKF is now being asked for more holistic information in relation to our firm compared to 12 months ago. The focus used to be solely on demonstrating technical capabilities, relevant experience and scale. Our modern slavery policy or gender statistics never got an airing. But this is starting to change.
It’s clear to us that companies are now placing greater demands on their supply chains and business partners in order to demonstrate their own commitment to ESG. They are seeking demonstrable evidence that those they partner with have an ethos similar to their own and see discernment in this area as a key part of their own ESG obligations.
Several large insurers have already come out and said that they want their operations and supply chains to be ‘net zero’, and we expect this and similar targets to be more widely adopted.
Intermediaries will need to be ready to disclose their own ESG strategies and commitments (and before too long, their own ESG performance metrics) to their risk carrier partners. Having this information in a reportable format, and having a positive story to tell, is going to be key in maintaining strong insurer relationships. It may even become a prerequisite for entering into new ones.
The number of intermediaries publicly talking about their commitment to, and progress with, ESG is still relatively small. Although the format and content of public disclosure is evolving, there are bodies (such as the Sustainability Accounting Standards Board) that have developed frameworks for companies to use. These principles have been adopted by many blue chip organisations, including Marsh and Willis. But beyond the global industry players, few companies have yet developed comprehensive ESG public disclosures.
The focus on intermediaries’ stance on ESG is only going in one direction. So we recommend that all brokers give thought to what relevant information they wish to communicate to the outside world, and identify any obstacle to being able to do so.
The outside world’s impact on your business
For insurance companies in the UK, there are already regulatory requirements (most notably the PRA’s Supervisory Statement SS3/19) that govern their management of financial risks stemming from climate change. All insurers have been required to take steps to embed climate change considerations into their governance and risk management processes, as well as to undertake scenario analysis. They are also expected to set targets for climate change commitments, and metrics to begin measuring their progress towards them. But the level of progress across the industry is mixed, with many insurers still trying to understand what a proportionate and meaningful set of metrics and targets for their business looks like (see Aviva’s 2020 Climate-Related Financial Disclosure as a comprehensive insurer example).
Intermediaries are not immune to the risks posed by climate change. The risks being identified by insurers are going to flow through the supply chain somehow – and are already doing so. Here are examples:
- Changes to underwriting methodology. Be it the increased frequency and severity of extreme weather events or the changes in mortality rates caused by rising global temperatures, many insurers are updating their underwriting processes and assumptions to take account of the increased physical, transition and liability risks from climate change. Intermediaries, in particular MGAs, need to understand the impact of these changes on their own business lines.
- Development of climate conscious products. To meet their own climate related targets, insurers are developing new products. These may be to meet societal needs relating to new risk exposures from climate change, or from an increased demand for green/ethical policies. Intermediaries must understand the changing needs of their client base, as well as the changing suite of products available for distribution.
- Potential changes in capacity provided by markets. Lloyd’s set a market-wide policy to stop new insurance cover for coal, oil sands and Arctic energy projects by January 2022, and to pull out of the business altogether by 2030. This is likely to be the start of a growing trend of risk appetite changes driven by ESG policies, which will impact heavily on intermediaries operating in certain sectors.
Although these examples are focused on the impact of climate change, the principles will likely extend into the other areas of ESG as and when regulatory requirements or reporting standards begin to expand.
Many insurance intermediaries may take the view that none of this is going to happen for several years, so it needn’t be a focus for management. But never before has our firm seen such a broad range of voices across regulators, standard setters and society, talking so much about a risk management and financial reporting topic. And all are saying the time to act is right now.
It’s also worth noting that many investors and private equity backers are asking ESG-related questions today as part of their valuation and investment decisions. This is adding weight to the need to pull ESG thinking and reporting forward – for many businesses who are seeking (or wishing to maintain) external funding.
How will ESG-focused companies benefit?
This may sound like a lot of work to add to management’s already long list of things to do. But, rather than just being a compliance exercise, we see some clear opportunities for intermediaries who are early movers in this space.
Investors continue to demonstrate a significant appetite for assets in the insurance sector. With many of them looking to support a green economy, demonstrating that your business has ESG considerations at the heart of your strategy is only going to make you more attractive and push multiples up. We encourage companies to see this as more than a ‘tick-box’ exercise and think about how it can be integrated into the wider business strategy.
Nor should the opportunities presented by new business lines be under-estimated. As our world begins to transition to a low carbon economy, what new kinds of technology will spring up to help us achieve this? As the diversity of our workforces begins to shift, what impact will this have on ways of working? All these transition risks present opportunities for new and innovative products – and intermediaries have a key role to play in this evolution.
Keeping Generation Z happy
What is very clear across all sectors is that ESG factors will also play a big role in attracting and retaining talent in the future. Numerous surveys looking at what Generation Z want in a job show that whilst pay and benefits continue to be the most important, these are closely followed by how aligned the employer is to their own values. Articulating a well presented set of ESG objectives, clearly linked to the firm’s purpose and strategy is key. Demonstrable evidence of positive progress towards these objectives will go a long way towards helping the talent of tomorrow decide whether your business is something they want to be part of.
For more information about the issues raised in this article, please contact Martin Watson.