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Boosting ESG Due Diligence For the Insurance Sector with RegTech

5th August 2024

Boosting ESG Due Diligence For the Insurance Sector with RegTech

The pressure to address climate and social issues is greater than ever. Companies are now scrutinised by watchdogs, employees, investors, and customers, all demanding thorough documentation and assessment of their strategies for tackling these crises. Environmental, Social, and Governance (ESG) issues have become integral to a business’s overall strategy, and stakeholders are increasingly unwilling to trade with companies that fail to take these pillars seriously.

An Overview

While ESG isn’t a new occurrence, it has gained increased prominence in the last five years due to the skyrocketing pressure from stakeholders to address both sustainability and social issues affecting the globe. According to a Bloomberg study, global ESG assets will surpass $50 trillion by 2025. Moreover, approximately 79% of investors consider ESG management as a crucial factor when making investment decisions, and almost 50% of investors would cease doing business with a company that fails to respond to ESG agenda, according to a recent PwC Global Investor ESG Survey.  

The significance of ESG can’t be stressed enough; but more importantly, stakeholders are starting to call for ESG due diligence reports to mitigate investment risks. In this blog, we will delve into the meaning of ESG principles, the importance of thorough ESG due diligence, the challenges facing the insurance market regarding ESG data collection, and how RegTech can enhance the effectiveness of ESG due diligence processes.

What is Environmental, Social and Governance (ESG) and what does it stand for?
What is ESG and What Does it Stand For?

Environmental, Social, and Governance (ESG) is a measurable evaluation of a company’s sustainability and ethical practices. An effective ESG strategy involves setting specific performance targets, tracking progress through audits and ensuring transparency in reporting. Unlike corporate social responsibility (CSR) which is a non-regulated internal strategy for bettering the environment and society that could indirectly impact a company’s reputation, ESG is regulated and could potentially interfere with how compliant a business is with local and international laws. Besides, ESG principles also protect investors by highlighting potential risks associated with unethical business conduct. 

WHAT ESG PRINCIPLES STAND FOR >>

Environmental: This aspect includes corporate policies on climate change, energy consumption, waste management and animal treatment. Companies are evaluated on their efforts to reduce their environmental footprint and contribute positively to environmental sustainability. 

Social: These principles assess a business’s relationships with stakeholders such as employees. Companies are expected to implement diversity and inclusion (DEI) initiatives, promote employee volunteering, contribute to community development and ensure ethical practices in their supply chains. 

Governance: Governance principles focus on maintaining ethical standards in accounting and financial reporting. They also measure the diversity of senior executives, salary equality and adherence to ethical business practices. Good governance ensures that companies operate honestly and responsibly. 

The insurance market faces increasing regulatory scrutiny to ensure ESG compliance across operations and partnerships
ESG and the Insurance Industry

The mounting complexity of regulatory requirements and heightened scrutiny from regulatory bodies are pushing the insurance market to demonstrate their commitment to the environment, their people, their customers, and society at large. Additionally, they must ensure their trading partners are ESG compliant. This shift is driven by a cultural change in how insurers, MGAs, carriers, and brokers collaborate to address environmental and social issues.

According to PwC, insurers are uniquely positioned to influence ESG outcomes due to their pivotal role in the market. They have the responsibility not only to address their own ESG practices but also to shape the behaviours of others, thereby accelerating progress towards ESG goals throughout the distribution chain. Besides, it’s about leaders’ and senior managers’ mindsets, their communication of these issues to their teams and audiences, and the steps they take to inspire action in the best interest of the planet and its people. In fact, research conducted by the CII Broking Community New Generation Group has found that the grasping of ESG targets is not entirely aligned between all seniority levels within insurance companies, and usually the more senior a person gets, the more they understand their firms’ ESG targets. 

In the United States, the National Association of Insurance Commissioners (NAIC) along with the US Securities and Exchange Commission (SEC) have respectively recently released a climate risk disclosure survey and a requirements proposal in response to growing investor and stakeholder concerns about climate issues and the need for a low-carbon economy. While in the UK, the FCA continuously supports regulated businesses, especially in the insurance and financial services sectors, by providing ESG guidance and rules to help firms develop their ESG strategies.

The four challenges that surround ESG due diligence
ESG Due Diligence Challenges in Insurance

ESG due diligence in insurance involves evaluating an insurance company’s or an insurance product’s adherence to ESG criteria. This process helps insurers identify and manage risks, seize opportunities and align their operations with broader sustainability goals. The primary aim of ESG due diligence is to mitigate risks and ensure companies are adhering to relevant regulations and laws, effectively addressing social inequality and climate issues. Additionally, regulatory bodies require firms to conduct regular ESG due diligence checks on their partners and ensure they’re acting appropriately to address ESG issues. 

However, increasing regulatory requirements and scrutiny are putting pressure on insurance firms. Challenges such as lack of resources, expertise, clear direction, and understanding are affecting firms’ abilities to comply with ESG practices and assess their trading partners’ adherence to these standards. Below, we summarise four main challenges surrounding ESG due diligence facing the market:

1. Don’t Know Where to Start:

Most of the time, the reason why insurance companies fail to successfully carry out ESG due diligence checks is because they don’t know what to do or how to do it. They usually struggle to develop an all-round 360 strategy that encompasses all three pillars, but it becomes even more complicated when dealing with the counterparty. Additionally, measurement methods and inconsistent definitions often confuse companies which impacts the evaluation of ESG efforts.  

2. Not Investing in Proper Technology:

Legacy processes are increasingly inadequate for managing the frequency and complexity of evolving regulatory laws. As government officials and watchdogs implement advanced ESG policies, the insurance industry is struggling to keep pace, particularly due to insufficient investment in technology that supports effective ESG due diligence. The complexity of the insurance supply chain further complicates this issue, making it challenging to collect and manage data throughout the entire chain and to stay updated on changes as they occur.

3. Not Sure How to Align Underwriting to Climate Issues:

Aligning underwriting with climate issues remains a significant challenge for the insurance sector. It demands the integration of ESG data into risk models to assess the impact of climate change on assets, predict environmental risks, and meet both regulatory and customer expectations—all while ensuring profitability. This underscores the need for robust ESG frameworks and real-time data to support informed and sustainable underwriting decisions.

4. Data and Reporting Challenges:

Collecting ESG due diligence data on trading partners can be complex, and with the wrong technology, it could take up months to gather the right information. As HSBC affirms: “A key challenge is to find transparent, credible and valid ESG data and gather it into an efficient platform that enables efficient and meaningful metrics to evidence ESG outcomes.”

The importance of adhering to ESG and sustainable practices and what are the consequences in case these standards are neglected?
Why Adhering to ESG Practices is Important
1. Risk Management Reasons:

– Climate Risk Mitigation: Sustainable practices help insurers manage and mitigate climate-related risks. By promoting policies that reduce greenhouse gas emissions and encouraging resilience against climate change, insurers can lower the frequency and severity of claims related to extreme weather events, natural disasters and other climate impacts. According to PwC, 62% of global insurance CEOs whose firms have made a net-zero commitment list that the need to mitigate climate change risks was a high influencer. 

– Enhanced Underwriting Accuracy: Incorporating ESG factors into underwriting processes allows insurers to better assess risks and price policies accurately which leads to more sustainable and profitable underwriting practices.

2. Staying Compliant and Avoiding Fines:

Adhering to ESG compliance regulations and performing due diligence on trading partners helps insurers avoid costly penalties and sanctions. In the U.S., regulators are cracking down on environmental policy violations with significant fines. For example, in 2022, the SEC fined BNY Mellon Corp. and Goldman Sachs Group Inc. $1.5 million and $4 million, respectively, for ESG compliance failures and other misstatements. These penalties mark the SEC’s first significant actions against financial institutions for ESG issues, signaling a serious stance on environmental compliance and greenwashing, according to Edel Brophy, Global Director of Regulatory Compliance at Fenergo.

In the UK, the FCA introduced the Sustainability Disclosure Requirements (SDR) rule in late 2022 to enforce sustainability and anti-greenwashing measures, which came into effect on May 31 of this year. While the SDR is the current major ESG regulation, Davis Thomas, Managing Associate at Linklaters; “It’s only a matter of time before we start seeing some enforcement action from the European regulators as well”. 

3. Long-Term Financial Performance and Resilience:


– Investment in Sustainable Assets: Insurers gain from investing in sustainable assets, which tend to be less volatile and provide long-term returns. This approach supports their need for stable, long-term investment outcomes to meet future liabilities.

– Operational Resilience: Adopting sustainable business practices boosts the overall resilience of insurance companies. It enhances resource efficiency, reduces operational costs, and drives innovation in products and services. Embracing ESG standards not only improves financial performance and fosters long-term growth but also strengthens the firm’s reputation among stakeholders, including customers, investors, and regulators. This adherence to ESG principles offers a distinctive competitive edge.

The importance of conducting ESG due diligence on insurance firms' partners.
Why Conducting ESG Due Diligence on Trading Partners is Crucial

Know Who You’re Doing Business With: It’s crucial for insurance firms to ensure partners adhere to ESG standards. Conducting ESG due diligence on these partners prevents firms from associating with environmentally and socially irresponsible companies, which can have long-term negative impacts on stakeholders and customers. Investors, customers, and businesses increasingly prefer to engage with companies that incorporate robust ESG practices into their business models. 

Strengthening Your Company’s Reputation: Conducting ESG due diligence checks on trading partners is crucial for avoiding reputational damage. Working with trustworthy partners who recognise the importance of contributing positively to society and the environment ensures a collaborative effort to achieve broader ESG standards. These checks are also critical in working to achieve the United Nation’s Sustainable Development Goals (SDGs), which helps in strengthening a company’s reputation and gaining new customers, according to KPMG.  

Complying with ESG Regulation: In the UK, large firms with annual turnovers exceeding £500 million are required to report on ESG practices. While smaller firms are not subject to mandatory ESG compliance laws beyond the SDR, it remains crucial for insurance companies to conduct ESG due diligence. This is particularly important for those trading with businesses in Europe and the U.S., where ESG regulations and ratings are more stringent. Meeting the expectations of consumers, employees, stakeholders, and investors is imperative; PwC reports that 75% of investors believe companies should address ESG issues, even at the expense of short-term profitability. Regulatory watchdogs in the UK also expect the insurance sector to integrate ESG policies and strategies into their business plans. Many firms actively report on their ESG efforts to align with these expectations. To support brokers on their ESG journey, BIBA published documents and guidance last year and collaborated with the law firm Weightmans to highlight the business importance of considering ESG.

The role of RegTech in carrying out ESG due diligence checks
How RegTech Can Help With ESG Due Diligence?

While RegTech helps insurance firms stay on top of their regulatory compliance requirements, it is also a powerful tool that allows businesses to have complete end-to-end oversight over their ESG due diligence duties. RegTech software is developing very fast to account for addressing the planet’s sustainability hurdles. 

Stakeholders and regulators expect firms to report on their ESG initiatives. RegTech simplifies this process by enabling firms to conduct ESG due diligence in minutes, regardless of the complexity of their supply chain. By centralising data on a single platform that integrates seamlessly with existing databases, RegTech ensures continuous compliance checks are performed. However, these checks alone are insufficient to keep up with rapidly evolving ESG regulatory frameworks. Hence, RegTech solutions are advancing to facilitate the smooth collection of enriched, clean, and reliable ESG data. According to KPMG, RegTech is advanced at identifying potential ESG issues in future investment assets and enabling financial managers to make informed, strategic ESG-related decisions.

RegTech provides real-time, reliable data on potential business partners, ensuring firms collaborate with responsible entities. A significant advantage of RegTech for ESG due diligence is its ability to send and receive information to one or thousands of recipients within the supply chain, centralised in one repository. RegTech platforms offer dynamic dashboards, allowing firms to automatically track crucial ESG metrics and information, ensuring clear visibility on partners’ ESG strategies.

RegTech solutions ensure adherence to industry best practices and regulatory requirements, simplifying the comparison of ESG performance across different businesses. This capability aids insurance companies in making informed decisions, mitigating risks related to ESG factors, and protecting both reputation and revenue.

By integrating RegTech into operations, insurance firms can meet regulatory and stakeholder expectations while contributing positively to ESG practices. This technological advancement not only supports compliance but also fosters sustainable business practices, enhancing long-term growth and resilience.

ESG plans and due diligence cannot be neglected anymore
Conclusion

Gone are the days when investors and consumers overlooked ESG considerations. Today, insurance firms must embed ESG principles into their business models and rigorously address climate and societal issues. Additionally, firms are now compelled to conduct ESG due diligence on their partners, as global regulators demand stricter reporting on ESG efforts.

RegTech streamlines this process for insurers and financial services firms by providing real-time, reliable data and a centralized system for managing and tracking ESG metrics. This ensures compliance with industry best practices and regulatory requirements while aiding in risk mitigation. By leveraging RegTech, firms can efficiently meet the heightened expectations of stakeholders and regulators, demonstrating their commitment to sustainable and responsible business practices.

Speak to one of our experts to learn how REG Technologies can help you.

This article was published by:

Article author:

Manal Tjiou

Manal Tjiou is the Marketing Executive at REG Technologies. With a passion for digital marketing and creative strategy, she’s commited to increasing our brand awareness and thought leadership in the industry, ensuring our content resonates well with our audience.

020 3946 2880

info@reg.uk.com

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