Dan Reynolds, the editor-in-Chief of Risk & Insurance, sat down with Jarrod Schlesinger, the regional head of financial lines at Allianz Commercial, to discuss the impact of ESG concerns on the financial lines sector, the role of AI on corporate America, and the current state of the directors and officers market.

Risk & Insurance: What is the impact of ESG concerns on the financial lines sector?

Jarrod Schlesinger: ESG has become a catchall term, and it’s important to disaggregate its components — environmental, social and governance — rather than lumping them together. Many people use ESG to primarily discuss environmental issues, but it encompasses much more than that.

It’s crucial to clarify which specific aspects of ESG are being addressed in any given context. Despite the challenges in defining ESG, it remains an incredibly important topic for companies to focus on, and consequently, it’s equally important for the insurance industry to consider its potential impact.

In our underwriting meetings, we strive to break down ESG into its component parts and engage with clients about their philosophy and approach to each element. However, there is no singular answer to getting ESG right, as it is a complex and multifaceted issue that requires careful consideration and ongoing dialogue.

R&I: What is your perspective on the importance of specificity when discussing ESG as an underwriter, particularly in the context of tailoring coverage?

JS: When it comes to ESG, especially environmental factors, it’s crucial to be as specific as possible. We need to understand how these issues impact a company, its goals for emissions and carbon neutrality, and its overall approach.

It’s about finding the right balance in terms of disclosure and action. Companies must be careful not to over-report, under-report or misrepresent their ESG efforts. If they make a claim, they need to follow through on it.

This is where terms like “greenwashing” and “greenhushing” come into play. Greenwashing refers to companies exaggerating their environmental efforts, while greenhushing means not discussing them at all. There are always two extremes: those who want companies to prioritize the environment and those who focus more on shareholder value.

When considering ESG, especially environmental factors, it’s important to think about the true purpose of a company. Is a company meant to be a political entity and take a stance, or is a company’s sole reason for existing to create shareholder value?

R&I: Have there been regulatory actions or shareholder lawsuits related to companies not aligning their ESG statements with their actions?

Jarrod Schlesinger, Regional Head of Financial Lines, Allianz Commercial

JS: Yes, there have definitely been lawsuits and regulations surrounding ESG. We’re still in the early stages of ESG, and everyone is trying to figure out what it means and what they want it to be. The topic is somewhat political in nature, with different groups prioritizing environmental concerns, shareholder value or a balance of both.

Lawsuits have occurred around greenwashing, and states have put in parameters about ESG disclosures and frameworks. There has also been litigation surrounding diversity on boards of directors. However, the potential for litigation is likely much greater than what we’ve seen so far, given that we’re still in the early stages.

Companies are learning to lean into ESG initiatives and focus on actually doing what they say, rather than just using the right vernacular. As an underwriting company, our focus is on helping our clients mitigate the risks associated with ESG.

One way companies are mitigating the risk of overpromising is by setting long-term goals, such as aiming for carbon neutrality by 2050. This gives them time to figure out what it means and how to achieve it, rather than setting unrealistic short-term targets. Companies are also using more cautionary wording about what they’re saying and how they’re saying it.

R&I: What role does an insurer play in advising clients on the language they use in their public disclosures, such as 10-K filings or public statements?

JS: As an insurance carrier, we absolutely emphasize the importance of language and how companies communicate about all aspects of their business.

Insureds receive guidance from various trusted advisers, including insurance brokers, carriers, lawyers and accountants. These professionals are becoming increasingly savvy about the significance of language choices, not just in written documents but also in public statements, such as appearances on financial news shows.

The key is to be cautious about what is said and to use qualifying words to avoid making definitive promises like “We will achieve X by Y date.” Such statements leave little room for flexibility and can potentially lead to issues down the line.

R&I: What are the risks associated with generative AI, particularly in the context of financial lines?

JS: Generative AI is an incredibly interesting and important topic, but we are still in the early stages of understanding its implications. As with ESG, AI is a big topic that will likely see many legislative iterations over time, and its full impact remains to be seen.

One of the primary concerns surrounding AI is the potential inaccuracy and unreliability of its results. AI learns from patterns and structures in the input it receives, drawing conclusions and generating new data with similar characteristics. This means that if the inputs are wrong, biased or discriminatory, the outputs will reflect those same issues.

Companies need to be cautious about the extent to which they rely on AI and be transparent about their use of the technology. There have been instances of lawyers using AI-generated briefs that contain incorrect case law, highlighting the risks associated with overreliance on AI.

Just as with greenwashing, there is a risk of “AI washing,” where companies overstate their use of or reliance on AI. On the other hand, not using AI enough could lead to accusations of being a dinosaur and falling behind competitors.

While we are seeing early-stage lawsuits related to AI, these cases are still new and have not yet gained significant traction. As the technology continues to evolve, it will be crucial for companies to strike the right balance in their adoption and use of AI.

R&I: What are the primary claims and losses related to AI that you are seeing in the industry?

JS: The main claims I’ve seen revolve around companies overstating their use of AI. There seems to be a perception among investors that if a company says they use AI, it means they are a growth company. However, some claims allege that these companies aren’t really using AI as extensively as they claim or question how exactly they are utilizing the technology.

I think we’ll start seeing companies disclose more details about their AI usage and applications to address these concerns. As we’re in the early stages of AI adoption, there’s potential for significant impact and disruption, akin to a “nuclear weapon” in terms of importance, as Warren Buffett reportedly stated.

To manage the risks posed by AI, we need to start putting in place robust frameworks and regulations. Companies will likely begin implementing these measures, and we can expect to see governments at both the state and federal levels taking action as well.

Key questions that will arise include: How are you using AI? What does it mean for your business? How can you control it? These issues extend beyond just D&O concerns, such as the rampant use of AI on college campuses and its broader societal implications.

R&I: What are your thoughts on the importance of having a coherent policy or framework in place to govern the use of AI within organizations?

JS: Having guidelines in place is crucial, both internally and from a regulatory perspective. However, simply setting guidelines is not enough; organizations must follow through on them. Failing to adhere to these guidelines can lead to problems.

In the short term, regulations can provide a roadmap for litigation. If an organization fails to meet the requirements outlined in the regulations, it can be seen as a breach. Over time, as people become more comfortable with AI and understand its implications, we may see a shift in how these regulations are interpreted and applied.

For us, the key is to ask questions of our insureds about how they are using and approaching AI. While companies can prohibit employees from using AI at work, it’s important to recognize that they have access to numerous AI sites through their personal devices. This raises questions about how companies can ensure the truthfulness and accuracy of the information being put out.

I believe that AI is ripe for regulation and corporate guidelines. Its evolution may be similar to that of ESG, where we will continue to understand its meaning and impact over time. Ultimately, we will likely find a middle ground where we can operate somewhat safely.

R&I: What role do you think AI can play in the editorial process, and what challenges do you foresee?

JS: People often seek curated information and tend to accept what they read as fact, especially online. However, just because something is published on the internet doesn’t necessarily mean it’s accurate or real.

Companies are held to a high standard of disseminating accurate information. AI could potentially assist in the editorial process, but it would require careful discernment and oversight to ensure the veracity of the content.

R&I: What impact are inflation and other macroeconomic factors having on the financial lines sector, particularly in terms of losses?

JS: Inflation and macroeconomic conditions can significantly impact the financial lines sector. For individual companies and entire sectors, inflation and higher interest rates pose challenges, particularly in terms of supply chain costs.

Manufacturers facing increased input costs must decide how much of that increase to pass on to the end buyer, depending on their pricing power and willingness to do so. Companies that can successfully pass along the additional costs will likely fare better, although this may not be ideal for the consumer.

High interest rates also affect long-term planning decisions, such as building new factories or opening new stores, which can have lasting impacts. Additionally, inflationary conditions often lead to rising wages, putting pressure on companies’ bottom lines and potentially creating HR-related issues.

These macroeconomic conditions can also contribute to bankruptcies. According to U.S. court files, bankruptcy filings increased by 16% in the 12 months ending in March. While this may not be as evident among large companies, it’s important to note that the country’s economy relies more heavily on small businesses.

R&I: What factors led to the failure of several regional banks in 2023, and how do they compare to the strength of larger banks?

JS: I believe there are a couple of factors at play. Firstly, the asset-liability management practices caused some of the initial issues at these institutions.

Secondly, many of those banks lacked diversity in their lending and depositor pools, which made them more vulnerable to market fluctuations.

Thirdly, they faced a net interest margin issue, where the interest they paid out on deposits was higher than the interest they received from loans they had already made. This disconnect is often a timing issue, as it takes time for these things to correct.

These initial banks may have survived if not for the unpredictable run-on-the-bank event that was triggered by their concentration of large number of uninsured depositors. While many feared that the banking industry was facing a contagion event, the government’s decision to back uninsured deposits, along with the prudent balance sheet management by the vast majority of banks, demonstrated the banking industry’s resilience to macroeconomic issues.

Larger national and global banks, on the other hand, have much better diversity in their depositor base, loan portfolio, and the businesses they are involved in. This allows them to better withstand economic cycles.

However, I view regional and community banks as incredibly essential to the economy. They are the ones lending to normal businesses, mom-and-pop shops, restaurants, car dealers, country clubs and so on. A significant issue with these banks would be detrimental to the broader economy.

The government’s decision to back uninsured depositors in those couple of banks is interesting. While it should give people the opportunity to diversify their holdings if they have more money in the bank than is insured, it may also lead to complacency, with people assuming the government will always provide such backing. Reasonable risk management would be to diversify better.

The banking sector is a prime example of how macro issues can impact an entire industry, as we discussed earlier in the context of the macro economy.

R&I: What are your thoughts on the potential for more banks to face issues, given the current state of commercial real estate and the significant increase in bankruptcies?

JS: While there is certainly potential for more banks to encounter problems, many regional banks are taking steps to shore up their operations and improve their position, including lowering their exposure to commercial real estate, particularly with commercial office space in certain regions. However, it’s likely that some banks will still struggle and require government intervention.

Generally, we’re seeing these struggling banks being acquired by larger banks or stronger regional banks, rather than outright failing. This is a positive outcome overall and demonstrates the resiliency of the U.S. banking system.

Since the failures seen in 2023, some time has passed without a significant number of weekly bank failures. While we’re not entirely out of the woods yet, it appears that banks are starting to manage the situation better, which will hopefully avert any concerning increase in the rate of bank failures.

When engaging with our banking clients, we focus on assessing their real estate loan portfolios, net interest margins, and the diversity of their portfolios and depositor bases. Having these in-depth discussions with our clients allows us to better understand and manage the risks associated with the current banking environment.

R&I: In the context of our discussion, particularly regarding the D&O insurance that falls under your purview as the head of financial lines at Allianz Commercial, what key insights would you like to highlight for our readers?

JS: D&O insurance is indeed one of the critical products within the financial lines that I oversee. In the current market landscape, it’s crucial for organizations to understand the significance of robust D&O coverage.

Given the increasing complexity of the business environment and the evolving regulatory framework, directors and officers face a myriad of challenges. A well-structured D&O policy provides essential protection, allowing them to make decisions confidently while safeguarding their personal assets.

Moreover, as we navigate through these dynamic times, it’s imperative for insurers to adapt and innovate. At Allianz Commercial, we remain committed to delivering comprehensive and tailored D&O solutions that align with the unique needs of our clients, helping them mitigate risks effectively.

R&I: What can you tell our readers about the current capacity and pricing trends in the D&O market, either generally or within your company?

JS: The D&O market is currently competitive, with numerous carriers vying for the same business, which can lead to pricing pressure. Basic economics of supply and demand come into play when there is greater supply than demand, resulting in downward pressure on prices.

However, it’s crucial to consider the quality of the carrier you’re doing business with, particularly their balance sheet strength and ability to pay when needed. At Allianz, we take pride in our robust balance sheet and our ability to fulfill our obligations, backed by the highest possible financial ratings.

Macroeconomic conditions also impact financial lines. With fewer new businesses being created, a slowdown in IPOs and an increase in bankruptcies, there are fewer opportunities for carriers to acquire new clients. This scarcity further intensifies competition, as more carriers compete for the same or a diminishing pool of clients seeking insurance.

R&I: What advice would you give to clients navigating the current risk landscape, especially considering factors like inflation and emerging technologies?

JS: Our primary responsibility is underwriting, which we take very seriously. While topics like high inflation and the emergence of AI are real and deserve attention, we underwrite to them. It doesn’t mean we run out of the market when faced with these challenges.

As carriers, brokers, insureds and other advisers, we work through these issues collectively, which is crucial. I recommend that clients rely on their advisers — including brokers, lawyers, accountants and carriers like us — to provide information, ideas and risk mitigation tools.

As a carrier, we produce a lot of content, such as the annual Allianz Risk Barometer and the D&O Insurance Insight report. Our ESG experts dedicate significant time to helping clients meet their ESG goals and improve their disclosures. Additionally, our claims teams across all businesses are available to help clients understand and mitigate risks before they need to file claims.

The best advice I can give clients is to engage in active risk management, risk assessment, good corporate governance, communication, transparency, compliance and adherence to ethical standards. These practices will help clients mitigate losses and become better insureds and risks compared to others in the market. &