Five trends at the root of ESG risks
Environmental, social and governance (ESG) metrics can be difficult to measure, but the risks around them increase as governments and citizens pressure companies to change their habits for the greater good.
Despite the shock it has inflicted across the world, the COVID-19 crisis does not appear to have stopped ESG activists and agendas in the boardroom. On the contrary, it seems to have accelerated it, because the concern for collective well-being has been highlighted.
Social justice protests have taken place during the pandemic and environmental activists have taken to the streets, reflecting continued concern over ESG topics such as climate change and diversity.
But it’s not just the citizens who are putting the pressure on. The action of investors and shareholders is increasingly focused on ESG. A series of regulations and guidelines in many jurisdictions lead to stricter disclosure and reporting rules for companies and their directors and officers (D&O). Growing concerns about social inequalities are also driving new demands on companies in terms of diversity, compensation and supply chains.
Companies, their D&O – and current and future D&O insurance underwriters – need to be aware of ongoing global ESG issues in order to properly assess potential dangers and how they may manifest in terms of potential liability. Here are five ESG risk trends on the radar of commercial insurers:
1. Actions against climate change and pollution
The coronavirus pandemic may have pushed climate change low on the board’s list of concerns in 2020, but a series of extreme weather events have seen it come back to the fore this year. Unprecedented forest fires, a winter storm in Texas, the “heat dome” over parts of North America, and flooding in Europe and China have changed the perception of climate change from an abstract peril to a daily risk. There is also increasing pressure from activists and society on governments and businesses to address this.
The sense of urgency was reinforced by the recent historical report the UN-backed Intergovernmental Panel on Climate Change (IPCC), which issued a ‘code red for humanity’ and warned that the world would likely hit the key warming threshold of 1, 5 ° C within 20 years, unless rapid and far-reaching action is taken to reduce emissions. “It is unequivocal that human influence has warmed the atmosphere, the oceans and the land,” the report’s authors wrote. The report precedes COP26 of the United Nations Climate Change Conference in Glasgow in November 2021, when delegates will attempt to finalize the “Paris Rulebook” – the rules needed to implement the Paris Agreement.
As the world moves towards a low-carbon future, we are seeing an increase in climate-related legislative activity and a change in the regulatory landscape. In the United States, President Joe Biden has pledged to reduce carbon emissions by 50% by 2030 (from 2005 levels) and put the country on the path to carbon neutrality by mid-century. The European Green Deal sets similar targets for reducing carbon emissions.
Litigation related to climate change is on the rise, “strategic” cases – or those aimed at creating societal change – are increasing dramatically. According to a report published by the London School of Economics, the cumulative number of climate change-related cases has more than doubled since 2015. More than 800 cases were filed between 1986 and 2014, while more than 1,000 cases were filed in the six last years. Much of the litigation has revolved around disclosure when companies and boards have failed to adequately disclose the material risks of climate change. For example, there have been lawsuits in the United States where it was alleged that companies failed to disclose changes in the environment that led to wildfires and how this could negatively impact the environment. business.
Corporate boards have a critical duty to ensure strong corporate climate accountability with proper reporting and due diligence. The prospect of a risk of litigation linked to climate change increases all the more as there is a gap between what a company does and says internally and what it does and says externally (even more so in the to the extent that any statement or public action by a company could contravene a framework).
Pollution and environmental disasters are also of concern. Following incidents such as the explosion of a dangerous cargo or the collapse of a dam affecting an ecologically sensitive area, the boards of directors of the companies involved are increasingly questioned about their strategies for managing pollution. risks to prevent such events and to what extent they were aware of potential risks.
2. Diversity of the board
Diversity issues are becoming more and more important and companies are increasingly under scrutiny. This was seen in the wake of the Black Lives Matter protests of 2020, which were followed by an increase in diversity litigation, particularly in the United States. board of directors or in management positions.
With changes in regulations and diversity laws increasingly likely, the risk of D&O litigation will increase further, as will the risk to a company’s reputation if it is found to be negligent in this area. For example, the United States Securities and Exchange Commission (SEC) recently approved a proposal by stock operator Nasdaq that requires its listed companies to have diverse boards or explain why they don’t. The UK Financial Conduct Authority reviews diversity requirements as part of its listing rules.
A number of studies have shown that diversity improves risk management and the financial performance of a board of directors. A 2019 study by McKinsey & Co. found that companies in the top quartile when it comes to gender, ethnic and cultural diversity in their management team were 25% more likely to have above-average profitability or outperformance on profit margin before interest and taxes (EBIT). than companies in the fourth quartile. Diversity also brings benefits to recruitment and can help fill skills gaps and talent shortages.
In an increasingly interconnected world, diversity of race, age and gender should be a governance priority for all boards. While it may be too early to talk about a trend in D&O claims, the frequency of diversity lawsuits filed since early July 2020 should raise concerns that any business without racial, gender diversity. and age on its board of directors may be affected by lawsuits.
Another expected impact on the D&O insurance market is the kind of information that underwriters will look for and the questions that can be expected in customer / carrier meetings. D&O underwriters will increasingly be interested in understanding how important diversity, equality and inclusion are to the leadership team and how this is reflected in key performance indicators.
As the pressure on companies to improve their carbon credentials increases, concerns have been raised about ‘green laundering’, when companies produce misleading information to exaggerate their ESG credentials and present a more responsible public image. With the increase in lawsuits from stakeholders and investors in this area, directors should be careful not to set unrealistic ESG targets that they may not achieve, or they may become the subject of litigation. For example, lobby groups often use institutions’ own ESG reports when it comes to assessing progress on carbon neutrality goals.
4. Compensation of the CEO
Executive pay is another potential hot potato, especially for investors. The $ 1 trillion Norwegian sovereign wealth fund – one of the largest in the world – is just one of those that have developed an active management of executive compensation proposals in the companies in which it invests, amid concerns about pay transparency. Several large global companies have announced that they are linking executive compensation to ESG and climate-related goals and outcomes, such as greenhouse gas reduction. According to a study published by PwC, nearly half (45%) of FTSE 100 companies linked executive compensation to ESG objectives, with just over a third including an ESG measure in their bonus plans.
Although measures such as health and safety, risk and employee engagement have been part of the premium for some time, the new ESG targets for executive compensation reflect emerging stakeholder concerns about climate change, sustainability and diversity.
Investors increasingly expect boards to reflect a broader view of the company’s responsibilities to their stakeholders, but their goals must be realistic and achievable, or they may not resist a challenge. meticulous examination.
Whether it’s the rise of working from home, accelerating digitization, or the large-scale effects of the ransomware attack on the colonial pipeline in the United States, the potential and real vulnerabilities exposed by cybercrime and other cyber incidents have become shocking over the past year. . The consequences of a data breach in terms of financial costs and reputation for a business can be serious – even if it is the result of an accident – and high-profile cases have raised ESG concerns, particularly regarding the sustainability of businesses. .
Investors are increasingly concerned with building corporate cyber resilience. Potential cyber exposures become an essential part of any merger and acquisition process, especially since an acquiring company can be held responsible for incidents that predate a merger.
Shanil Williams is Global Head of Financial Lines at Allianz Global Corporate & Specialty. Based in Munich, Shanil leads a global team delivering a suite of financial line insurance solutions uniquely designed to meet the responsibilities of companies, managers and professionals in today’s increasingly contentious and demanding business world. hui.
This article is printed here with permission from AGCS.