As business demands and expectations evolve, corporate boards and leaders are increasingly being held accountable for their organization’s environmental, social and governance (ESG) strategy and performance. It is therefore unsurprising that ESG is increasingly becoming a significant risk-selection component among underwriters for Directors and Officers Liability Insurance (D&O).
Proper oversight of ESG materiality factors is imperative. Organizations that do not actively manage or address this topic open themselves up to potential litigation risk or regulatory investigations and actions.
D&O insurers mostly rely on ESG ratings from outside agencies that claim to offer stakeholders a clear picture of how a company is managing ESG risks. However, with a proliferation of ESG ratings providers and no standardized methodologies, there is now greater recognition that ratings might not tell the whole story. This reality heightens the need for companies to proactively and thoroughly disclose their ESG oversight journey with D&O underwriters at renewal.
Why ESG Has Gained Underwriting Prominence
Underwriters face exposure to litigation on a broad spectrum of ESG-related matters, such as climate change mitigation and inclusion and diversity policies. “Greenwashing,” the practice of exaggerating claims about ESG progress and attributes, is also becoming a growing D&O litigation concern.1 Stakeholders, including investors, employees and consumers, increasingly expect companies to not only make commitments to ESG topics, but also hold them accountable when commitments are not met.
Similarly, many companies must make a number of ESG-related disclosures to comply with relevant regulations. To aid in these complex calculations of risk, ESG ratings firms evaluate companies’ plans, their adherence to those plans and how they stack up against their peers.
Because there is a solid connection between good governance (the G in ESG) and fewer, less severe losses in D&O, companies benefit from highly interested and engaged D&O insurers that offer competitive options in exchange for competent governance. Even further, incorporating a company’s environmental and social impact will help improve ratings and D&O policy renewal discussions, in addition to helping a company avoid red flags.
Ratings Don’t Tell the Whole Story
ESG ratings firms are increasingly scrambling to provide accurate, timely and relevant information as demand for ESG information continues to grow. To keep pace with the market, different ratings agencies are developing their own criteria to evaluate how well a company is mitigating ESG risks. Meanwhile, no industry-wide standards have been developed to help insurers and other stakeholders interpret the different ratings. Even if some agencies are using similar criteria, how they weigh each one can produce drastically different results, causing some to call into question the reliability of the assessments.2
Another challenge with ESG ratings is the elevated expectations that come with high ratings. Some companies in Europe are seeing that higher-rated companies face increased shareholder activism or threats of litigation. This is true either when targets are not met or when financial performance suffers. Investors are likely to ask if the company overcommitted or perhaps focused too much on non-financial issues, leading to poor performance.
How to Share a Compelling and Honest ESG Story
So how can companies overcome the inconsistencies with ESG ratings? The key is in the story behind the ratings. An outside party rating a company’s ESG efforts is only getting a snapshot of the company at a certain point in time. The rating may not necessarily incorporate where the company started on its ESG journey or the progress it has made along the way. A company can receive a poor rating that may not reflect the steps it took to reach its ESG goals or recognize the significant progress that has been made since the inception of ESG initiatives.
When talking about a company’s ESG story, it’s important to keep in mind the broad audience that is listening, including, among others, employees, prospective employees, investors, advisors, suppliers, competitors and insurance underwriters. Emphasizing different elements for each intended audience will help drive engagement with the company’s ESG story and strike an appropriate balance among competing interests. However, the company should have a strong overall narrative that’s backed by data and not only resonates with the various stakeholders, but also accurately reflects the company’s values and commitments.