ESG and supply chain risks
Environmental, social and governance [ESG] issues have become top of mind for business leaders in all sectors and momentum is growing rapidly as organisations prioritise their ESG agendas.
What are the origins of ESG?
The term ESG was first used in 2005 in a landmark study initiated by former UN Secretary-General Kofi Annan entitled ‘Who Cares Wins’. A subsequent report concluded that embedding environmental, social and governance factors in capital markets made good business sense, improved market sustainability and lead to better outcomes for societies. Today, the integration of ESG factors into investment processes and decision-making underpins responsible investing. Investors recognise that ESG information is invaluable to help understand an organisation’s corporate purpose, strategy and management quality. Demand for ESG reporting and metrics has reached the mainstream. For stakeholders and investors, ESG reports, disclosures and ratings take some of the complexity out of evaluating a company's ESG activities.
What does ESG mean for insurers?
For insurers, a key commercial driver can be seen in ESG being incorporated into the ratings of AM Best and other major insurance company rating agencies. There is also an increasing awareness that ESG information can improve investment portfolio performance, boost company reputation and improve risk management processes.
In order to mitigate risk and embrace the opportunities represented by ESG, insurers will need to consider new and dynamic approaches to risk modelling, investments, and business operations. Climate risk giving rise to changes and frequency of extreme weather-related incidents could lead to larger losses. New and changing regulation may lead to different business dynamics and considerations for commercial risk assessments and underwriting approaches. Insurers support many industries, all of which will have their challenges in meeting ESG requirements, whether that is e.g. modern labour standards, governance or carbon reduction. Insurers will need to be able to demonstrate that they are working to influence improving industry practices.
ESG reporting
New legislation comes into force on April 6 2022 enshrining the previously voluntary regulations created by the Task Force on Climate-Related Financial Disclosures (TCFD). The TCFD provided a framework for large companies to disclose climate-related financial information. The new legislation affects over 1300 of the UK’s largest traded companies, including banks and insurers, together with private companies with a turnover of £500 million+ and over 500 employees. Compliance with TCFD will require companies to disclose information about their sustainability in their annual reports. For insurers, this will bring a sharp focus to their investment policies and their operations. It will also include the need to assess and verify the green credentials of the companies that make up their supply chain as they implement a strategy to comply with the UK’s Net Zero commitment.
ESG strategies and policies
Organisations are developing and refining their ESG strategies and policies aligned to their industry, stakeholders and business objectives. Generic examples of the areas covered under the three elements of an ESG policy may include:
Environmental
- Corporate use of pollutants, chemicals and renewable energy sources
- Carbon and sustainability reporting
- Increasing sustainability in the supply chain
Social
- Inclusion and diversity
- Pay and rewards policies
- Community impact
Governance
- Board diversity
- Mitigating supply chain risks
- Transparency around corporate reporting
- Documenting, monitoring and reporting on governance, risk and compliance strategies
An insurer’s ESG policy will be inextricably linked with digital transformation because it is both a risk to be assessed and covered for customers and equally requires internal management on behalf of the insurer organisation. Digital transformation has been the aim of the insurance industry for many years and the ESG agenda will be a catalyst to sharpen insurers’ focus on digitalisation.
Reputation opportunities and risks
It’s not just investors who are scrutinising an organisation’s ESG commitments. Post the Covid-19 pandemic and the notion of ‘building back better’, combined with the powerful Attenborough Effect; consumers are looking to buy their goods and services from organisations that are taking better care of the planet and their people. In the latest survey conducted by Hyundai into greener, sustainable living, 51% of the 2,000 British respondents are planning to improve their sustainability habits in 2022 and believe the recent COP26 event and other news around the environment, have heightened their awareness of sustainability. Buying from sustainable brands was identified as a habit for 2022. Identifying and communicating ESG purpose and values offers organisations an opportunity to engage with the sustainability-conscious consumer and can help to positively influence their purchasing decisions.
Ageas Insurance has cited the climate crisis as the driver for its acceleration in the use of green, recycled vehicle parts as part of its motor claims proposition. Ageas has combined its salvage operation with its green parts supply, meaning if a customer’s car is written off in an accident, any perfectly good and undamaged parts from that car can get a new life by feeding into Ageas’s green parts supply chain. The insurer is now using green parts in around 1 in 5 of its vehicle repairs and is successfully promoting this strategy as a reputation-building, market differentiator.
Green Washing
The COVID-19 pandemic has further accelerated the ESG conversation, sharpening regulatory focus and scrutiny. Consumers, industry participants, civil society, regulators and the media are all increasingly questioning the integrity of some of the ‘green’ claims made by companies and financial firms. ESG will lead to greater scrutiny on directors and could open up a new avenue of claims against directors and officers in 2022. If a company’s ESG information and strategy is not accurately reported or falls short of expectations, then shareholders and regulators may be inclined to claim against directors for real or perceived ESG failures. D&O insurance considerations will need to reflect this risk.
ESG matters are high on the Financial Conduct Authority [FCA] regulatory agenda. The FCA states in its ‘Strategy for Positive Change’: “If the financial sector is going to help support the transition to a more sustainable future, market participants and financial services firms need high quality information, a well-functioning ecosystem and clear standards. And consumers need to be able to rely on firms to take ESG seriously, avoid ‘greenwashing’ and deliver on their ESG promises.”
Supply chain risk
By improving ESG performance throughout the supply chain, companies can enhance processes, reduce costs, increase productivity, innovate, differentiate and improve outcomes for the communities within which they operate. Corporate supply chains have become increasingly complex and ESG issues in the supply chain carry significant operational and reputational risk. Organisations must ensure that their ESG principles are consistent throughout their supply chain and wider ecosystem. Supply chain vulnerability can expose companies to hidden and uncontrollable risks that negatively impact ESG, these could include environmental pollution; shortages of raw material and natural resources; workforce health and safety incidents; labour disputes; human rights abuses, corruption and bribery and geopolitical considerations. For most global brands, their greatest exposure to undermining their ESG efforts and falling out of ESG compliance can occur in their supply chain.
In the financial services sector, evidence of the growing focus on supply chain and the need for scrutiny can be seen in the announcement made by Allianz Insurance in October 2021, when the company launched a sustainable procurement charter to encourage its suppliers to adopt and develop ESG practices. For future tender assessments, Allianz confirmed it would be applying a minimum weighting of 10% to ESG factors and prioritising suppliers who have embedded sustainable and ethical practices within their organisation. Similarly, LV=General Insurance [LV=GI] has launched its ‘Green Heart Supplier Promise” working with its supplier partners to become market leaders in sustainable and ethical procurement. Supplier Promise outlines the key focus areas and the commitment required by all contributing parties in the LV=GI supply chain. Suppliers must achieve ‘Green Heart Standards’ which set specific environmental, social and governance targets and measures.
ESG Solution by CRIF
The financial sector can create value through “sustainable finance”, supporting credit policies, commercial strategies, supply chain selection, risk management and funding. Responding directly to customer demand and recognising market need, CRIF has drawn on its experience and methodology as a global credit rating bureau and invested in research and development to design a new solution enabling clients to mitigate risk by validating the ESG information provided by their supply chain companies. The ESG score developed by CRIF, applicable to all business sectors, validates and scores the supplier against five key areas: business, environmental, social, governance and industry. Country-specific procedures mean the solution can service clients with a global supply chain.
To achieve an ESG score, suppliers are required to complete a detailed online self-assessment questionnaire, and uploading documents and data via CRIF’s ESG digital platform. By completing the questionnaire, the supplier self-declares the actions taken by the company to meet all ESG principles. CRIF uses multiple data sources to cross reference, analyse and validate the information provided in the responses, requesting further information as necessary. The platform calculates the overall ESG score accordingly, divided into five classes descending from A to E. Suppliers can download their ESG Certificate, which is valid for 12 months, and promote it on their website as part of a worldwide standard. Their score and certificate can be used as evidence for multiple customers across different geographies. The fee for the transactional, ‘pay as you go’ service is paid by the supplier.
