Articles - ESG a dissonance headache for the insurance industry


Environmental, Social, & Governance (or ESG) is now a buzzword on the lips of directors, shareholders, and regulators alike. The last few years have seen a flurry of activity across many sectors of the economy, with the insurance industry no exception. Examples of ESG actions often include stronger commitments to board and employee diversity and plans to achieve carbon “net zero” operations.

 By Ed Harrison, Senior Consultant at Lane Clark & Peacock
  
 Insurers face a particular challenge grappling with ESG because of a dissonance between the quicker adoption of these more internally focussed policies and the much slower progress applying the same ESG principles to insurance products themselves.
  
 Examples of this conflict include:
 • Environmental dissonance: Taking steps to become operationally net zero, whilst generating significant revenue from underwriting fossil fuel projects.
 • Social dissonance: Operating an ethical supply chain but using controversial pricing practices (such as motor insurance price walking).
 • Governance dissonance: Promoting corporate transparency but being taken to court over interpretation of policy wordings.
  
 So why is ESG progress in insurance underwriting proving so challenging, and what can be done to move the industry forward? In the first of this two part series, we consider the “E” of ESG.
  
 Climate change – is data dependency slowing the industry down?
 The insurance industry is built on data. Insurers are drawn towards risks where there is a rich history of claims experience to help with underwriting, pricing, and reserving. Unfortunately this means that insurers are also likely to be biased towards providing capacity to more traditional sectors where data is readily available, with a risk premium attaching to new sectors and technology where it isn’t.
  
 In practice this can mean a preference in the London market for insuring fossil fuel-based energy ventures over renewable technology, or insurers shying away from covering eco-homes due to non-standard construction methods.
  
 To combat this data-availability bias and help insurance provide better risk transfer capacity to the sustainable economy, new approaches are needed. Three possible approaches include:
 1. Adopting pricing and reserving approaches using alternative data.
 2. Encouraging data sharing initiatives between insurers.
 3. Promoting more use of public data.
 
 Pricing / reserving approaches using alternative data
 Insurers can pioneer new approaches to pricing and reserving for risks with limited historical data. Innovative technology and start up “green” technology doesn’t usually lack data – what it usually lacks is data of the type & format insurers are used to using, ie neat triangles of historical claims experience. The insurance industry has responded to this type of challenge in the field of cyber insurance already, but the same approach can help in other emerging risk areas.
  
 Investing in bespoke modelling for the risks posed by emerging technologies will help insurers establish credibility in underwriting “green” risks, and help develop a competitive advantage as these market segments inevitably grow.
  
 Data sharing initiatives
 Greater sharing of data between insurers can help the whole industry provide better quality product offerings in developing areas.
  
 This doesn’t come instinctively to insurers or to regulators. The former often regard data as their “Crown Jewels”, whilst the latter might take a dim view of data sharing from a competition / antitrust perspective.
  
 However, there have been numerous examples of how data sharing has helped enhance the industry overall. Take personal motor for example, the CUE (Claims and Underwriting Exchange) database is used by insurers to confirm that prospective policyholders’ declared accident experience is accurate. It has helped motor insurers reduce the propensity for fraud, which has in turn helped keep premium rates lower than they would otherwise be.
  
 Use of public data
 The insurance industry can also look externally to obtain relevant data and help reduce the dependence on historical claims information.
  
 In the short term, use of public data or modelling may help resolve challenges posed by a changing climate or economy reducing the relevance of rich historical datasets. For example in nat-cat modelling, recent extreme hail, windstorm and wildfire events in the US have demonstrated that there is increased physical risk in a major market arising as a result of climate change. Insurers whose pricing models depend primarily on historical claims experience will likely be under pricing these catastrophe risks. In contrast, insurers seeking relevant, recent environmental data and working in partnership with specialists developing climate change focussed meteorological models will be much better placed to confidently accept those risks at an appropriate rate.
  
 Longer term, the industry has the opportunity to diversify away from its reliance on policyholder and claims data and work in partnership with governments and academics to develop public datasets, to the benefit of insurers and other industries alike.
  
 According to a recent Cambridge University ClimateWise paper [1], key policy opportunities include standardised public data capture, development of climate change indices and data sharing between insurers, the wider finance industry, and public bodies.
  
 Next steps for insurers
 It is clear that the insurers have a long way to go to solve their climate dissonance headaches and make significant progress towards climate friendly underwriting portfolios. It is equally clear that new sources of data and new approaches to analytics will play a key role in meeting insurers’ ethical underwriting strategies. Actuaries will be well placed to help the industry overcome data and modelling obstacles and take the next steps into a challenging future.
  
 In next month’s article we will move on to consider the Social and Governance aspects of ESG and how insurers can address these in their underwriting.
  
 References
 [1] University of Cambridge Institute for Sustainability Leadership (CISL 2021). The role of insurance underwriting in a changing climate: How policy can support sustainable underwriting https://www.cisl.cam.ac.uk/resources/sustainable-finance-publications/policy-opportunities-on-the-road-to-net-zero-underwriting
  

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