Tree blossom

ESG: The Growing Challenge and Opportunity

Daniel Bruce, Partner, Risk Consulting and Justin Elks, Managing Director, Risk Consulting
20/05/2021
Tree blossom

The increasing priority of ESG

ESG (Environmental, Social & Governance) is becoming the generally accepted term to describe sustainable, ethical and responsible investments, activities and practices. Each aspect of ESG covers a broad range of elements, each of which themselves contain varying degrees of complexity.

Over the last couple of years, there has been a groundswell of engagement, and increasingly action, in relation to climate change, led by environmentalists such as Greta Thunberg and powered by social media. COVID-19 has also highlighted the benefits of climate change action, through a clear reduction in pollution. The insurance industry plays a key role in helping customers manage their climate risks, investing in assets and providing long-term finance to support economic growth, so can exercise a considerable influence over companies and individuals. However, as climate risk events increase, the continued insurability of these risks is challenged. Insurers will be instrumental in determining how well ESG and climate related risks are managed across the whole economy.

More recently COVID-19 has, perhaps understandably, diverted focus from climate change; but one of the lasting impacts from the pandemic may be a greater sense of societal cohesion, and a greater appreciation of the benefits of social good. Social risk topics have been highlighted during the period of the pandemic; race-related incidents and unresolved issues have led to civil unrest, and the reputation of the insurance industry has been in the spotlight through discussions of the validity of Business Interruption insurance claims. Insurance is essentially a promise to pay; public trust is dependent on the industry’s wider social purpose.

Finally, financial services organisations in the UK, and across Europe, have significantly enhanced their governance arrangements over recent years, driven largely by regulation. In insurance and wider financial services there is continued pressure for an increasingly diverse leadership and workforce. There is also increasing regulatory pressure in respect of how governance arrangements (including risk management) proactively consider ESG factors.

ESG considerations need to be well thought out

ESG considerations are an important part of how businesses can support their employees, customers and broader society during the pandemic, and can help to build back a better future while meeting increasing regulatory and investor expectations.

ESG considerations need to be sincere, and not seen as obvious “greenwashing”, which can cause more harm than good to an organisation’s reputation. For ESG to really be a success, not only do each of the three elements need to develop and progress, to support the organisation’s strategy and purpose, there also needs to be a greater degree of linkage and integration between them. This integration is difficult to achieve through regulation alone, and requires organisations to see the benefits that can be realised through a joined-up approach.

The link with purpose and strategy

To provide steer and direction on ESG, it is imperative to explicitly link it to the organisation’s purpose and strategy. This may be a strong, direct link, or more indirect, where the ambition for ESG is aligned with purpose and strategy, rather than a formal part of.

Once the link with purpose and strategy has been established, it is good to articulate the ambition for the extent to which ESG matters are integrated into the decision making and operational processes across the business. A key part of this is about identifying where a company is going to focus its efforts – those companies who have been most successful in embedding ESG within their business have a strong focus on those areas which they care about, that support their strategy and that fit with their organisational values.

To set this ambition such that it is achievable and realistic, a number of challenges need to be overcome:

  • A relative lack of knowledge of ESG across the organisation; this can require training and engagement activity, to help to bring together coherently potentially diverse or misaligned views.
  • There are a wide range of stakeholders who need to be engaged, with different concerns; including the Board, senior management, customers, employees, shareholders, third-party suppliers and regulators.
  • Balancing the short and the long-term; ensuring that the ambition balances the need for a coherent and achievable business plan over the near term (noting the articulated link between ESG and strategy) while addressing the longer-term impacts of, for example, climate change and the shifts in societal needs and preferences.
  • Ensuring a joined-up approach across the individual elements of ESG, and across the organisation; overcoming this issue is not trivial, and it can require some strong change management activity in order to ensure that ESG principles become embedded and that the agreed ambition is achieved.
  • Integrating ESG into the ERM framework, and communicating how risk management activities support the successful delivery of the ESG ambition; it can be a challenge to avoid another siloed, separate framework.

To help with all these challenges, it is helpful to have a consistent way of communicating ESG to all stakeholders. We have a found that a simple diagram, with supporting commentary, can show the key areas of consideration and highlight the need for an integrated approach. Crowe’s ESG framework, described at its highest level below, provides an example of this.

Crowe's ESG Framework

Crowe has created a framework that shows the key areas of consideration for ESG, while highlighting the need for an integrated approach:

Capturing the benefits

While the risks to the financial system of ESG are self-evident, another of the challenges is for individual firms to be able to quantify the benefits of ESG related activity, to help support and justify the investment of resources. These benefits can be difficult to measure in numerical terms, because many of the outcomes either don’t have a direct financial impact, or because the benefits may be delivered over a longer-term time horizon than the typical business planning period.

The main areas of benefit include:

  • developing and maintaining a strong, trusted brand and reputation; both in absolute terms and relative to peers
  • attracting and motivating talent; increasingly, current and potential employees are expecting their employers to have a strong ESG-related purpose and strategy that fits with their values
  • greater productivity, reduced costs, improved resilience and lower regulatory intervention
  • opportunities for growth and innovation; for example, through new or tailored products and improved competitive position
  • optimised investments, and better access to capital.

Although they may be difficult to measure, studies now consistently show that a clear and coherent approach to ESG, and climate change in particular, can help companies be successful over the long term.

Leading practice

So, what do we see leading insurers doing to ensure that the full range of benefits of ESG are delivered?

  1. Linking their ESG path to their organisation’s purpose and strategy.
  2. Keeping their activities practical, with a clear destination in mind. The best firms focus on those areas that their firm can realistically change and influence, particularly in relation to the E and S components of ESG.
  3. Understanding and addressing regulatory expectations, but driving their ESG programmes from a business perspective, in the knowledge of the regulatory constraints.
  4. Thinking about what they have learned from Covid-19, in terms of operational resilience, a greater sense of social good and the need for new products and services.
  5. Ensuring their approach to ESG is integrated, both across its components and across their organisation, so that the approach is consistently applied.
  6. Involving their third parties too, so that they understand and meet their expectations. This can help to ensure that stakeholders don't see the activities of partners as being in conflict with your ESG approach and messages.
  7. Continuing to focus on regular communications and any cultural challenges; these are often the hardest part to get right!
  8. Tracking progress and the delivery of the benefits. Be honest about failures - and share successes.

Conclusion

Linking ESG to your organisation’s purpose and strategy can help set a realistic, achievable ambition. Combining this with a structured approach to delivering the ambition helps to deal with the various challenges that ESG represents and maximises the benefits that can be realised.

Contact us

Daniel Bruce
Daniel Bruce
Partner, Risk Consulting
London
Justin Baxter
Justin Baxter
Partner, Risk Consulting
London