Change is coming: ESG in underwriting

It’s early days for ESG integration in underwriting, but things are moving fast, says Salman Siddiqui (pictured), Senior Director, Industry Practice Lead for Insurance,  Moody’s Analytics, and a keynote speaker at our Climate Risk and Sustainability conference. We spoke to him for a pre-conference Q&A.

To what extent have we seen ESG making inroads across the value chain in insurance?

Currently, the carriers are leading on ESG efforts, more so than the reinsurers and the brokers. Reinsurers are stepping up their efforts, and we’re seeing a lot of noise from brokers who want to do something on ESG.

Most insurers, though, are in the portfolio analysis stage – understanding internally what their portfolio looks like, what the hotspots are, and socialising the analysis internally to develop their public commitments. Over time, we’ll see some insurance companies start to integrate ESG into the pre-binding stage.

What’s driving the integration of these issues?

There are three factors. The first is managing reputation risk through adverse media or protests. Then there’s increasing emergent regulation around disclosure for ESG, such as the TCFD [Task Force on Climate-related Financial Disclosures], as well as investors asking for more information on what companies are doing regarding their ESG posture. That’s one angle and probably the dominant one so far. We surveyed insurance companies, and 90% of companies identified downside risks as their primary driver.

There’s another driver, though, and that’s upside potential: An opportunity to attract cheaper capital, identify new growth and product opportunities, and help understand and service their customers better. We’ve already seen innovation with companies developing products to target cleaner risks or positive societal impacts. According to our survey, 40% say upside potential is driving adoption of ESG; that number is up from 30% the year before, and it might be up to half by the end of this year.

There’s also the possibility that if you can demonstrate correlations between ESG scores and underwriting performance and loss ratios, then in theory, you could start using ESG data in pricing models.

Finally, there’s a big issue about attracting talent to the industry. If you look at the new generation coming through, surveys show a significant proportion will decline employment at organisations that are not taking ESG seriously. If you want to continue attracting good talent to the industry, you need to take this seriously.

Has there been too much attention on the “E” of ESG?

Naturally, the attention has been on the “E” as that’s where much of the policy focus and action has been. So we’ve seen the Net-Zero Insurance Alliance and the carbon accounting all focused on climate change, reducing emissions, and supporting transition. So the focus on that has been considerable, as it should be. But, first, climate change is just part of the ‘E’ of ESG; there are other issues within it, such as biodiversity, waste management and pollution.

Moreover, if you focus solely on the environmental side, you ignore the need for a just transition, making sure that it is equitable, and that’s where the social and governance part of ESG is just as important.

What are some of the challenges when integrating ESG in underwriting?

Private entities and SMEs in the portfolio are a real challenge. Most insurance companies only have about 10-20% of the insured portfolio that are large caps. The bigger portion will be SMEs and private companies, where it is much harder to get ESG data.

Another issue is that there are different views on ESG. The market needs to agree on what they mean by ESG and good disclosure and the information they need to understand their portfolios. Just like RMS standardised nat cat risk decades ago so that you could trade that risk across the value chain, the market needs to coalesce around a standard for ESG.

Integrating ESG is a four-stage approach. Step one is to look at your portfolio first, understand the heatmaps and footprint, and where the issues are; step two is to engage with your insured clients and brokers to educate them on what you’re doing. The third is to start thinking about the point of underwriting, and step four is thinking about pricing and selection. Most insurers are currently on stages one and two.

But what I would say is that it is changing fast. I’ve not seen a topic in insurance take off this fast before. If I look at Solvency II, IFRS17 or any seismic changes that have hit insurance in the last 20 years, ESG has moved more quickly than any of them. Just 18 months ago, nobody was talking about ESG for underwriting; now, it’s on the agenda of every seminar, conference and meeting we have. It’s moving at a pace I’ve not seen before in the industry, which means we’re finding solutions to these challenges quickly. We should get to an inflexion point in the not-so-distant future.

Salman Siddiqui will be speaking on Integrating Climate Risk into your Underwriting Decision-making to Manage Exposure at Climate Risk and Sustainability in Re/insurance Europe on June 7, 2023.

Did you get value from this story?  Sign up to our free daily newsletters and get stories like this sent straight to your inbox.