ESG Initiatives: How to Prioritize Sustainability and Avoid Legal and Financial Pitfalls

In a recent webinar, presenters discuss the origins of ESG practices, how businesses are responding and the overall impact on commercial insurance.

By: Gregory DL Morris | October 3, 2022

When it comes to society-wide initiatives growing in popularity, sustainability has an outward focus, while environmental, social and governance (ESG) issues have an inward focus.

“Sustainability is the right thing to do, while ESG is the smart thing to do,” said Phillip Ludvigsen, senior associate for green finance and litigation support at First Environment, an environmental engineering and consulting firm.

“Comprehensive risk management [can] result in financial benefits such as lower cost of capital, lower frictional cost, lower insurance costs — especially directors and officers — and higher return on equity.”

Ludvigsen was the lead speaker for webinar “ESG – Building a Program, Insuring the Risks,” addressing the insurance implications of ESG on insurance sponsored by the law firm Anderson Kill.

For a definition of sustainability, Ludvigsen cited the 1987 World Commission on Environment and Development. It issued a report formally titled Our Common Future, but is commonly known as the Brundtland Report.

It stated that sustainability is “meeting the needs of the present without compromising the ability of future generations to meet their own needs.”

Under those needs, he included economic, environmental, and social.

From Individuals to the Corporate World

Many date awareness of how human activity affects the environment to 1962, when Rachel Carson published Silent Spring.

While recognizing the landmark importance of that work, Ludvigsen cited written accounts of environmental awareness in the early 16th century.

Amy Barnes, head of sustainability and climate change strategy, Marsh

He also noted just a few years after Carson’s expose, President Lyndon Johnson stated that the current generation “has altered the composition of the atmosphere on a global scale through radiation and a steady increase in carbon dioxide from the burning of fossil fuels.”

Referring to that declaration, Ludvigsen said, “when people tell me, ‘well, we just didn’t know’ [about environmental degradation]; we did know. And it’s been studied for a long time.”

That length of study has yielded a strong business case for ESG, Ludvigsen asserted.

“There is enterprise value brought to bear, both in value added to the enterprise, and in risk management. For companies that can do those things well you would expect their share price to increase over time.” (See image below.)

Businesses Enter the ESG Game

The global capital markets clearly concur, and as evidence, Ludvigsen noted there are 3,800 signatories to the international Principles for Responsible Investing, representing $103 trillion in assets under management. Furthermore, net flows into ESG funds that are available to U.S. investors “skyrocketed to “$20.6 billion in 2019, four times the level of 2018.”

Stressing that nearly 60% of ESG funds outperformed the wider market over the past decade, Ludvigsen cautioned, “You do not want to be on the wrong side of ESG where you are putting at risk your access to capital.”

Ludvigsen also takes issue with the broad assertion that there are insufficient global standards for ESG reporting.

He noted that more than 400 technical standards established by the International Organization for Standardization have been mapped for to ESG, some in great detail.

For example, ISO 14030 for green bonds and other debt instruments.

“I see directors and officers who issue large debt say, ‘we’re not having third-party verification or assurance over this because there is no global standard.’ Well, that’s not true. In my opinion that is an error, it is an omission, and it could be a misrepresentation.”

Another webinar speaker, Enrique R. Ubarri senior managing director at FTI Consulting, who has implemented ESG programs at several large public companies, concurred.

“A successful program can drive access to a wider pool of capital, lower the cost of capital, enhanced value creation, improved employee morale and talent recruitment, and an enhanced and differentiated corporate brand.”

Dennis J. Artese, chair of the climate change and disaster recovery practice group, shareholder, Anderson Kill

William G. Passannante is a shareholder and co-chair of Anderson Kill’s insurance recovery group and also spoke during the two-hour webinar on ESG. Passannante noted the evolution of corporate governance from shareholder primacy, advanced by Milton Friedman in 1962, to a more comprehensive view comprising other stakeholders including the community, customers and employees. That was championed by the Business Roundtable in 2019.

With circumspection Passanante added that the change “complicates D&O liability.”

Amy Barnes, head of sustainability and climate change strategy at Marsh, addressed during the webinar some of the ways that ESG is affecting insurance, stressing that “for underwriters, ESG is a measure of sustainability,” and that “insurers are interested in both sides of the balance sheet.”

That is in their underwriting selection, including philosophical alignment in their client and investment portfolios.

“We have a hypothesis that there is a strong correlation between ESG and risk,” said Barnes. “We think we are going to find that companies that have strong ESG will have a better risk profile than others. We have started to test those relationships.”

The first was D&O. Using publicly available data from the U.S. Securities & Exchange Commission, and third-party ESG assessment frameworks, Marsh found a strong correlation, especially in governance.

“Companies with strong governance had fewer, or less severe D&O losses that those without.”

Putting an even finer point on it, she added that it was likely “anyone with responsible for D&O will have increased curiosity from their D&O underwriters around ESG.”

There were also finding in liability and property.

Pivoting back to climate, Barnes explained that “a huge amount of capital deployed in the U.S. is from European insurers, and the trend is accelerating.” She added that many insurers are members of the UN-convened Net Zero Asset Owners Alliance, and that the UN has also created the Net Zero Insurance Alliance.

The latter “now has more than 27 members, and at the start of 2022 had more than 40% of the listed non-life insurance capacity in Europe, and more than 2/3 of listed non-life re-insurance capacity. So it’s massive. All of those insurers have collectively said that they are steering their portfolios to net zero.”

What Should Happen Next

For all those lofty intentions, the devil, as always, is in the details.

Barnes cautioned that “the insurance industry needs to develop underwriting systems before it’s got the data. And the insurance industry — which I think is a fantastically innovative industry — does not always innovate quite at the speed we need it to. If you are a risk managers or buyer, you need to be really demanding and clear with your insurers, where you need them to innovate and where you need support.”

To that point final speaker on the webinar panel Dennis J. Artese, shareholder with Anderson Kill and chair of the firm’s climate change and disaster recovery practice group, encouraged owners to assemble their response and claims teams in advance of any losses, particularly natural catastrophe.

“Establish those relationships well in advance of the storm.”

That team should include outside coverage counsel and the insurance broker, to help ensure perspectives and expertise beyond those of the insured company. It can also include a public adjuster, structural engineer, or forensic accountant for a business-interruption plan. &

Gregory DL Morris is an independent business journalist currently based in New York with 25 years’ experience in industry, energy, finance and transportation. He can be reached at [email protected].

Why Insureds Might See an Uptick in M&PL Claims

George Schalick, Jr., Senior Vice President of the Management and Professional Liability Division, Philadelphia Insurance Companies

The current soft market might come as a bit of a surprise as it does not track with previous underwriting cycles and economic conditions. Afterall, many privately held and non-profit organizations struggled during the early days of the pandemic with shutdowns and rapidly declining revenues. But the Government assistance programs, like the Paycheck Protection Program loans, helped keep many afloat during the tough times.

“During COVID many organizations stopped doing business until they were able to sort out all of the health and safety challenges,” Schalick said. “They were forced to lock down, but then all the government assistance programs allowed them to keep people employed. The increased volume of claims we anticipated we would see coming from the lockdowns and restrictions that were imposed upon businesses in the U.S. didn’t manifest at first.”

“Just because there wasn’t an onslaught of reported claims at the beginning of the pandemic, doesn’t mean the circumstances that would give rise to a claim being reported didn’t occur. Courts and the judicial system were closed or slowed and now that they are back open, we’re starting to see the circumstances that occurred during the COVID lockdowns becoming claims today,” Schalick said. “Litigation is progressing.”

Added to the delayed pandemic litigation is a concern over newer claims that might be filed as the country inches toward an economic downturn. Though a recession was avoided in 2023, experts think a soft dip could occur in 2024, with 76% of economists saying there’s a 50% or less chance of an economic downturn this year — that almost always results in more management liability claims.

“During the Great Recession in 2008, we saw an almost immediate spike in claims because of the economic conditions and the pressure it placed on organizations. They were making personnel changes with significant belt tightening almost immediately.” Schalick said.

What’s in Store for M&PL Policy Rates in 2024?

Despite an uptick in claims and increased economic uncertainty, management liability rates haven’t increased, resulting in market-wide pricing levels that may not meet the increased pressure of rising settlements and jury verdicts.

“Rates are going the other direction and settlement values are not falling,” Schalick said.

The mismatch between rates, claim frequency and severity is, in part, because carriers experiencing the dramatic soft market in the public D&O market are seeking premium gain in the private and non-profit market.

“In the public company market, the rates have been decreasing significantly. The rates were increasing in the private, not-for-profit market, and rightfully so, but there’s a desire to supplement overall mid-size D&O for carriers who also write private not-for-profit, and they see that as an opportunity to aggregate premium,” Schalick said. “So the always competitive landscape in the private, not-for-profit market has dramatically increased in the last 18 to 24 months.”

Still, companies of all sizes and types should be concerned about management liability rates in the future. Legal system abuse is resulting in increases in both the amount of litigation and the size of verdicts plaintiffs are receiving.

Certain areas of the country are particularly vulnerable to this type of legal system abuse. As a result, insureds in these localities are likely to be vulnerable to rate increases.

“The environment is so positive for the plaintiff that forces premium increases so carriers are able to stay in that market long term,” Schalick said.

Why a Tenured Carrier Partner Can Help Insureds Navigate An Uncertain Market

It’s clear that insureds are facing an uncertain M&PL market over the next few years. Fortunately, carriers with a long history in the M&PL space will be there to offer stability.

Philadelphia Insurance Companies has been supporting this market for 35 years. PHLY is committed to offering long-term rate stability, even as economic and claims trends start to push premiums upwards. They have an appetite for all sorts of companies, large and small, for-profit and nonprofit alike.

“We’ve been at this game for a long time and are one of the most tenured underwriters in this space,” Schalick said. “We like to stay very consistent.”

PHLY has worked with both for-profit and non-profit on management liability policies. With dedicated M&PL teams throughout the company’s 13 regions, PHLY provides the support agents and brokers are looking for on behalf of their clients. The teams know their regions well and can respond to local trends. They’re also dedicated to making the renewal process as easy as possible for their partners and policyholders.

“We have real confidence in our results, so we focus a lot on making the renewal experience as painless as possible for all agents and insureds,” Schalick said.

The company is also investing in tools to help insureds avoid losses. Earlier this year, they launched a new online risk management platform, PHLYGateway, which offers resources for insureds on how to create an employee handbook and trainings on issues such as recognizing workplace sexual harassment and discrimination.

If insureds have questions, they can consult a Best Practices Help Line, provided via the platform. That way, they can get on the spot risk management guidance to help them prevent claims.

To learn more, visit: https://www.phly.com/mplDivision/managementLiability/default.aspx.

This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Philadelphia Insurance Companies. The editorial staff of Risk & Insurance had no role in its preparation.