By Russ Banham
Carrier Management magazine
There’s a gripping moment in Shakespeare’s “Othello” when Cassio, hoodwinked by Iago into losing Othello’s trust, repeats, “Reputation, reputation, reputation! O, I have lost my reputation! I have lost the immortal part of myself.”
Once lost, reputation is rarely restored. And that is proving a problem for insurance companies and reinsurers that carry the risks of other businesses on their balance sheets. A reputation that is soiled by environmental issues, #MeToo allegations or executive embezzlement charges can trigger regulatory and legal actions, consumer boycotts, and a fast retreat by investors, producing potentially severe insurance losses for carriers.
That’s just one problem for the industry. Another is the impact on insurers’ and reinsurers’ reputations for insuring or investing in companies whose ESG (environmental, social and governance) considerations are questionable to subpar. A special report by ratings agency AM Best in mid-November 2020 emphasized that insurers and reinsurers that ignore ESG in their underwriting and investment decisions confront serious reputational risks. In turn, this risk can cause buyers and investors to flee to competitors, affecting the companies’ creditworthiness and ratings.
Are insurers paying scant attention to prospective and current insureds’ ESG factors?
Interviews with four firms that analyze and report on ESG in the industry suggest that on this subject, they perform about average when compared to other industry sectors, “with leaders and laggards,” said Nicole Bouquest, associate director at ISS Corporate Solutions, one of the four firms interviewed.
We reached out to a half-dozen large, well-known U.S. insurers to discuss how they are using ESG criteria in their underwriting decisions. All declined the opportunity to comment. We had more luck with European insurers and reinsurers like Zurich Insurance and Allianz, each responding affirmatively to the interview request.
Why the disparity in wanting to discuss a factor that should be integrated in an insurer’s underwriting decisions? Ross Hammond offered a reason: “U.S. insurance companies lag behind their European peers when it comes to climate action, the E in ESG,” said Hammond, senior strategist at Insure Our Future, which is composed of more than a dozen environmental and consumer protection organizations.
Many U.S. insurers and reinsurers are concerned that public knowledge of their underwriting and investments in fossil fuel companies will undermine their reputation, Hammond explained. “While most European insurers have limited or ended underwriting for new coal projects, he said, “most U.S. insurers still support new coal mines and power plants worldwide.”
Europe Takes the Lead on ESG
Some U.S. insurers like Chubb have made public statements about their intent to phase out insurance for coal mining companies and coal-fired plants and cease investments in coal companies, while others like AXIS Capital, The Hartford and MetLife have restricted insuring or investing in the tar sands oil sector. By contrast, other U.S. insurers, including AIG, TIAA, Berkshire Hathaway and Travelers, have yet to take any steps to restrict fossil fuel support, according to Insure Our Future research. “Many U.S. insurers continue to support organizations that lobby against climate action,” said Hammond.
Across the Atlantic, Zurich Insurance and Allianz are among a growing number of European insurers and reinsurers elevating the importance of ESG factors in their underwriting and investment portfolio determinations. “We’ve been on this journey to respond to ESG and especially climate change impacts since 2008, when we established a formal office on climate change and sustainability,” said Ben Harper, head of corporate sustainability for Zurich Insurance in North America.
A sponsor of the effort at the time was the global insurer’s head of general insurance, Mario Greco. Today, Greco is CEO. “Mario has made some very bold commitments on the global stage, taking a very strong stance on specific fossil fuel companies like coal and oil sands businesses, given their carbon intensity environmental impact of their operations,” said Harper. (Editor’s Note: After serving as CEO of General Insurance for Zurich, Greco left to become CEO of Generali in 2012, rejoining Zurich as CEO in 2016.)
In July 2019, Zurich Insurance stated that it would no longer underwrite or invest in companies that generate more than 30 percent of their revenues from oil sands or oil shale. It also said it would avoid companies that operated infrastructure such as pipelines and railways for oil sands projects. Greco said the policy was “simply the right thing to do. We see first-hand the devastation natural disasters inflict on people and communities.”
“It was a cutting-edge statement at the time,” said Harper, noting that other European insurers and reinsurers have since followed suit. “From an underwriting standpoint, our goal is to help customers transition to a low-carbon society, encouraging [efforts like] carbon capture and sequestration,” he said.
Nevertheless, he acknowledged the due diligence needed to compare different policyholders’ ESG criteria is challenging. “We don’t have the certainty we would like in the outside [ESG] data sources; we’re not saying they’re wrong, but ‘sustainability’ means different things to different people,” Harper said. “One ESG data provider may score a retailer a 4 out of 10 while another may score it a 7. It’s complicated.”
An example of these complications is an account that does not have a diverse board of directors. “Although there is strong research to reinforce that more profitable companies generally have diverse boards, we also understand that in certain parts of the world, it’s not easy to put together a diverse board,” said Harper.
Consequently, while Zurich Insurance screens and assesses current and prospective policyholder ESG factors in its underwriting and investment decisions, it does not score them per se. “We do not as yet have a strict standard of ESG scoring that says we will absolutely not underwrite or invest in a particular company,” Harper said. “If an account raises a red flag, it promotes an extra level of due diligence.”
This due diligence may ultimately be reflected in the pricing of the risk, which in turn may incentivize an account to improve ESG factors.
“One of the most influential tools an insurer has is risk-based pricing, a fancy way of saying we base our prices on a company’s actions and inactions,” Harper said. “At some point, [ESG] factors may reach a point where a company is not insurable. Eventually, the insurance world will say, ‘Yeah, you’re free to operate your business as you see fit, just know we value certain things and what you do has consequences.’”
When Reputation Become a Financial Risk
Allianz also has been at the forefront of integrating ESG into its underwriting and portfolio management decisions, creating a center for competence assisting these determinations in 2013. The carrier requires underwriters and investment managers to conduct due diligence into each client’s relevant ESG factors, insofar as how they may affect a client’s reputation and, by extension, its own.
“An underwriter that discerns a potential ESG reputational risk forwards these concerns to the center of competence, where we then take a closer look,” said Christopher Bonnet, head of ESG Business Services at Allianz. “The issue might just be allegations or maybe the problem has been solved. We do our own due diligence to either give approval for the risk to be written or not, based on certain conditions.”
Some conditions are immutable. According to Allianz’s ESG Integration Framework, the insurer has not financed coal-based business models since 2015. Equity stakes in the industry have been divested and fixed income investments made before 2015 are in runoff. In effect, no new investments in the industry are allowed. Moreover, Allianz does not offer insurance for coal power plants or mines and will not insure companies that do not fully phase out coal by 2040 at the latest.
“If companies do not present a credible strategy to transition away from coal at a pace which is compatible with the scientific pathways of limiting global warming to 1.5°C, we are excluding them from our business,” the carrier stated in April 2020.
Although Allianz has made clear which companies it will not insure or invest in, other prospective or current clients are assessed with an eye toward helping them manage their ESG-related reputational exposures. “We have to be cautious in applying exclusions; it is quite a blunt instrument that should be applied only when there are no other appropriate risk-based measures,” said Bonnet. “We’d rather use our leverage to engage a client to improve their ESG factors.”
An example is a power utility that generates a percentage of electricity by burning coal. Allianz has stated it will provide insurance to utilities that generate electricity from fossil fuels until 2022, at which point the customer must meet defined thresholds for coal-based production.
“We’re trying to influence the account to transition into an entirely carbon-free portfolio, urging they gradually use more renewable sources of energy like solar and wind,” Bonnet said. “In the end, this is about fully phasing out coal, but we understand the world needs electricity. It will take time for utility companies to reach this threshold. As long as we see progress in that direction, we’ll continue to insure the utility.”
With regard to single-site plants that produce energy entirely by burning coal, Bonnet said that Allianz “no longer supports” such companies, either underwriting the business or investing in the entity. Other industries are in the insurer’s crosshairs. “We’re faced with [insuring] mid-term industries like oil & gas, steelmaking, manufacturing and automotive that contribute to CO2 emissions, but not on the scale of and intensity as coal power plants.”
As the co-founder and member of the United Nations’ Net-Zero Asset Owner Alliance, which aims to reduce carbon emissions to net-zero by 2050, Allianz also expects to gradually reduce its investments in industries that damage the environment.
“Assuming these sectors make limited progress [in reducing their carbon footprints], we may need to take actions, but we’re encouraged by the number of de-carbonization initiatives currently underway,” Bonnet said.
New Administration in the U.S.
Although U.S. and European insurers and reinsurers are marching at a different pace to integrate ESG factors into their underwriting and investment determinations, stricter environmental reporting regulations ahead may quicken the pace for insurers on both sides of the pond.
In November 2020, the Bank of England announced that it will require the financial services sector in the United Kingdom to conduct climate change stress test exercises and disclose this information to regulators. Regulators want to be sure both insurers and banks have enough capital to offset carbon-related financial losses. Since insurers do not make products that harm the environment, the stress tests are designed to determine the possibility of losses coming from clients whose ESG issues may adversely affect insurer capital adequacy.
“If U.S. insurance companies fail to take action, it’s time for regulators to step in as they have in the UK,” said Hammond. “The good news is that U.S. voters have made it crystal clear they expect serious action on climate. Come Jan. 20 [when President-elect Joe Biden is inaugurated], U.S. insurers will no longer be able to continue ‘business as usual’ practices—not when business as usual involves underwriting and investing in industries and companies making the planet uninhabitable.”
Melanie Steiner, a board director at environmental services provider US Ecology Inc., shares this perspective. “What will drive ESG change systemically is regulation, but I also think there is a role for enlightened leadership to do the same; that, to me, is the most important thing,” said Steiner, who stepped down in November as chief risk officer PVH Corp., leading the large U.S. apparel company’s transformation into an environmentally sustainable organization.
“Right now, there is an opportunity when it comes to ESG for insurance company CEOs to be either a leader, a fast follower or a laggard,” she added. “They make this decision or regulators will make it for them. ESG is not going away.”
Russ Banham is a Pulitzer-nominated financial journalist and best-selling author.