ESG — also known as sustainability — is made up of environmental, social and governance factors. It began emerging in the 1990s, with international events and frameworks such as the Kyoto Protocol and more recently the Paris Agreement and UN Sustainable Development Goals. These helped reveal the extreme necessity and urgency for all sectors to find appropriate solutions to unprecedented global challenges.

We are currently witnessing a growing appetite of financial actors to understand the relationship between ESG factors and entities’ improved performance. The insurance industry is no exception, being highly affected by environmental changes. As the largest institutional investor group in Europe — and operating within long investment horizons — insurance companies play a major role in financing the move to a low-carbon economy. And as risk managers, insurers also play a central role in identifying and measuring material climate risks.

Consequently, to remain competitive, insurers need to adapt and innovate while factoring the above-mentioned risks into their strategic decision-making process. 

Generally, one of the challenges that all actors come across when implementing ESG-related strategies is the lack of standards and definitions. Therefore, comprehensive work has taken place to provide various industries with a clear framework. 

Back in 2012, the UN Environment’s Finance Initiative developed a framework for the insurance industry, supported by the UN Secretary-General and various industry CEOs: the principles for sustainable insurance (PSI) [1]. These principles were dedicated to help insurance actors manage sustainability risks while seizing opportunities, and to move towards a more climate-resilient economy.

The four principles are as follows:

1. We will embed ESG issues that are relevant to our insurance business into our decision-making process.
2. We will work with our clients and business partners to raise awareness of ESG issues, manage risk and develop solutions.
3. We will work with governments, regulators and other key stakeholders to promote widespread action across our society on ESG issues.
4. We will demonstrate accountability and transparency in regularly disclosing publicly our progress in implementing the principles.

Lately, credit rating agencies like Moody’s are including ESG factors into their ratings to better evaluate companies’ risk of default. As a result, they have identified high exposure and extensive vulnerabilities in the insurance sector and are urging insurers to consider a large range of ESG issues to meet their financial objectives. Furthermore, given insurers’ broad asset range of portfolios, there is a high chance that their value would dramatically decrease due to climate change. Yet, insurers oversee around 25% of worldwide assets.

In February 2019, the PSI and Allianz launched the first guide to managing sustainability risks in insurance underwriting [2] . The guide’s overall goal is to aid the ESG due diligence process for clients and transactions. It also provides guidance on developing approaches that integrate ESG risk considerations into the core business and related decision-making process.

In the background, stakeholders may be willing to understand the key aspects of ESG issues so they can assess the relevance of selected approaches. Applicable international standards and best practice frameworks will help insurance industry actors identify the elements required to build their ESG strategy. What’s more, the guide will add a rising awareness to not only ESG risks but also ESG opportunities, which could benefit the industry’s business models.

The guide addresses these challenges by exposing the following elements to insurance market players:

• ESG approaches
• establishment of risk appetite
• integration of ESG issues
• detection and analysis of risks
• decision-making about ESG risks.

However, while solutions are being developed to help the insurance industry make efficient ESG decisions, smaller insurance actors remain at a disadvantage. This is because they do not have the means to understand the latest updates affecting the industry and apply new frameworks and standards.

Regarding regulation, the insurance industry must keep a close eye on the EU’s action plan on financing a sustainable growth of March 2018 and its related legislative package. It includes two pieces of regulation that will have an impact on the sector:

• The proposal for a European Parliament and Council regulation on disclosures relating to sustainable investments and sustainability risks, foreseeing the following:
  • An insurance undertaking which makes available an IBIP (i.e. which sells an insurance-based investment product) that targets sustainable investments will be required to publish information related to these products and its benchmark, if any, on pre-contractual disclosures, websites and periodical reports.
  • An insurance undertaking which makes available an IBIP will be required to publish a sustainability risk policy on their website and include a description of how sustainability risks are integrated into pre-contractual disclosures.
     
• EIOPA’s technical advice on the integration of sustainability risks and factors in the delegated acts under Solvency II and IDD
  
  In April 2019, the European Insurance and Occupational Pensions Authority (EIOPA) published a piece of technical advice on the integration of sustainability risks and factors in the delegated acts under Solvency II and IDD. The amendment is predicted to impact these three major areas:
  • Incorporation of ESG-related preference information of policyholders and other beneficiaries into undertakings’ suitability assessments, investment strategy and global decision-making process.
  • Integration of sustainability risks within the prudent person principle.
  • Integration of sustainability risks into risk management areas.

As a result, insurance actors who anticipate and get ready for these future regulations — while factoring in investors’ increasing demand for sustainable products — will be best positioned to gain a competitive market edge.  

Julien Ganter
Sustainable finance expert
+352 22 51 51 7248
julien.ganter@kpmg.lu