As environmental, social and governance (ESG) issues are of increasing concern to the insurance industry, tremendous opportunities await Middle East insurers that plan and respond effectively to the fast-changing environment.
The insurance industry is built upon risk – quantifying, assessing, mitigating and managing the potential for sustaining losses due to a myriad of factors, from operational problems and systemic issues to the increasing frequency and intensity of extreme weather events.
Given this relationship, it is understandable that the industry has a vested interest in ESG issues and a growing number of insurers are becoming more aware of the importance of ESG practices and sustainable investing.
As a result, major organisations have worked on producing a clear framework for getting insurers behind ESG efforts. In June 2020, the UNEP FI’s Principles for Sustainable Insurance (PSI) initiative launched the first global insurance industry guide to tackle a wide range of sustainability risks. The guide outlines eight areas comprising possible actions for insurers to manage ESG risks and two high-level, optional ‘heat maps’ indicating the potential level of ESG risk across economic sectors and lines of insurance business.
Global rating agencies have also incorporated ESG factors into their ratings to better evaluate companies’ risk of default. As such, the agencies have identified high exposure and extensive vulnerabilities in the insurance sector, and are urging insurers to consider a large range of ESG issues to meet their financial objectives.
As ESG information is increasingly relevant to insurance companies’ decision-making, AM Best announced in December 2020 that it has refined its Best’s Credit Rating Methodology (BCRM) to enhance transparency as to how it contemplates ESG risks as part of the credit rating analysis. It also noted that ESG integration can reduce operational and reputational risks as identification of ESG factors can assist companies in identifying risks and opportunities that may not be captured by conventional financial metrics.
Middle East potential
The core of the insurance business is to anticipate, analyse and subsequently help our customers and clients to manage their risks, said RSA head of commercial lines, technical – Middle East Avinash Thiruvoth. With the evolving nature of issues related to the environment, societies and communities, the risk landscape is becoming more dynamic, which no doubt has implications on the insurance industry.
As of today, the Middle East insurance industry is at its early stage of understanding these implications and integrating them into their core functions, he said. However, a handful of international insurers, including RSA Middle East, are taking ESG and its impacts, not just on an insurer’s viability, but also as a responsible corporation, very seriously and have implemented new policies to demonstrate this. “At RSA Middle East, we believe all insurers should acknowledge the criticality of sustainable business practices and should explore new models and methods to encourage their customers and clients to do the same,” Mr Thiruvoth said.
Over the course of the last few years, the Middle East insurance industry has witnessed a paradigm shift in customer expectations with regard to technological advancement, increased regulatory requirements and social commitment to society at large, said Al Wathba National Insurance Company (AWNIC) CEO Bassam Adib Chilmeran. The outbreak of COVID-19, which affected our ways of working and living, brought up further challenges and questioned business sustainability. “The good thing is that a positive trend has emerged focusing on required pro-active measures in the direction of maintaining long-term sustainability.”
Awareness of ESG factors has increased significantly on account of the proactive measures taken by securities exchanges in the Middle East, with the notable ones being the ADX and DFM initiatives on sustainability reporting, said Mr Chilmeran. While sovereign wealth funds and select family houses have started integrating ESG approach into their investments, “the adoption from insurance companies has been relatively muted in the region”.
He added, “Although the integration of ESG factors is in its early stages, considering the impetus from regulators in the region, our insurance peers are definitely looking at their role and contributions not only towards shareholders but also on leaving positive influence on society and environment. I am optimistic that the momentum in the adoption of sustainable business practices and reflection on business transparency through ESG reporting will continue progressively in the coming years.”
AWNIC published its annual corporate sustainability report last November, becoming the first listed insurer in the region demonstrating its commitment to adopting sustainable development goals (SDGs) through its business value chain. “Operating in the insurance sector wherein trust matters the most, we remain committed to meet the expectations of our stakeholders by aligning our business model with the SDGs and working together for a positive future,” said Mr Chilmeran.
ESG adoption a necessity
ESG is a set of factors which when carefully reviewed with the associated risks and opportunities, assists organisations to form clear policies and direction towards sustainable business practices. A robust ESG policy helps the insurers’ decision-making especially around underwriting, risk management and asset management, focusing on sustainability, viability and regulatory compliance, said Mr Thiruvoth.
“In our opinion, a robust ESG framework is an absolute necessity, as the major future risk events predicted are all related to environmental and societal concerns. There could also be several interlinked consequences, as witnessed with COVID-19, which has far-reaching social, economic and environmental impacts,” he said.
Concurring, Mr Chilmeran said ESG adoption is more of a business necessity than merely a structure. All over the world the investment community is turning their attention to ESG-compliant investment products – evident from the meteoric rise of global sustainable investment, which now tops $40tn. “Before the push comes to a shove in the region, insurance players across the region are expected to place greater adoption of sustainability indicators in their underwriting and investment decisions. I believe regulatory interventions, awareness programmes and also governmental push on sustainability indicators will surely accelerate the ESG adoption,” he said.
Mr Thiruvoth said RSA also strongly believes that a strong regulatory framework around ESG will trigger a drive amongst insurers to review and revamp their operations. He added, “The events we all experienced globally in 2020 should be a trigger for a review of ESG policies among insurers. However, we believe that to accelerate the adoption of ESG policies and metrics we require strong advocacy from the board of directors (BOD). The significance of ESG and its subsequent implications on shareholders, customers, employees, communities and regulators should be brought to the board’s attention.
“Based on the steer from the BOD, management should prepare ESG integration strategies, policies and guidelines, and implement these involving all internal stakeholders with clear accountability. At RSA Middle East, we are a strong advocate of this and have already implemented initiatives with our clients to encourage stronger emphasis on ESG factors within their own internal business practices.”
Hurdles to address
A strong ESG proposition correlates with higher equity returns, corresponds with higher credit ratings and has shown to help companies tap new markets and expand into existing ones. A recent consumer survey conducted by McKinsey indicated that 70% of consumers would prefer to pay an additional 5% if the green product met the same performance standards as a cheaper non-green alternative.
“This is an important point that needs to be digested by the insurance industry in the Middle East that has largely of late been grappling with reduction in technical rates owing to cutthroat competition among the players. A much better understanding of the ESG concepts is essential for both companies and investors to be able to identify and manage those that are material to them,” said Mr Chilmeran. Apart from cutthroat competition among the players to maintain their share of the market, the Middle East insurance industry is also having a tough time owing to the hardening of the reinsurance market, and the customers getting spoilt for cheaper choices via aggregators who have emerged as major players in the last couple of years, he said.
Given the current market condition, he advised that in order for insurers to adopt the ESG principles consistently, effectively and efficiently across the value chain, “a holistic approach will need to be adopted rather than viewing it as a one-time activity”.
Mr Chilmeran said he foresees an increase in compliance costs for the industry in general on account of added reporting requirements on anti-money laundering and also with the adoption of IFRS 17 in the next two years. “This might create prioritisation dilemmas for the players in terms of adoption of the ESG concepts and principles which might be viewed as an additional cost burden.”
Furthermore, the prospect of educating all stakeholders, especially the investors and customers, remains a herculean task in the region. “This requires deeper understanding of business activity as well as data and resources. Sustainability factors also tend to introduce an extra layer of complication in the investment and underwriting decisions for which the companies might need to upskill the existing employees and also add quality resources. And finally the success of ESG adoption requires continuous board and management engagement,” he said.
Implementing any new strategies or transformations is difficult, “no matter where we are in the world”, said Mr Thiruvoth. However, specifically to this region, there are some key challenges insurers may need to overcome, when compared to other parts of the world. He said these include limited law and regulations related to ESG compliance and non-financial disclosures; relative lack of customer awareness on environmental and societal impacts; limited cooperation and understanding between distributors and/or clients of the concept of proper risk management; the region’s heavy reliance on fossil fuels for energy use; less stringent labour laws; and limited governance standards in place.
The inflection point
Many reports said the year 2020 was a turning point for sustainable finance. The COVID-19 pandemic has shone a spotlight on the fragility of the ecosystem and brought social factors to the forefront globally.
There is a strong argument that heightened awareness of the complex ESG challenges currently faced by society and the wide-ranging effects of the pandemic have accelerated the need for global businesses to demonstrate an express commitment to sustainability as an integral part of their individual business practices and external investment policies.
As one of a group of key stakeholders, the insurance industry is deemed to be uniquely placed to respond to the current economic and environmental uncertainties by creating and promoting viable financial solutions that contribute to more resilient and sustainable businesses, communities and economies.
While environmental and technological risks took the top spots in every future high severity loss potential list, no one predicted the devastating effects of a pandemic risk, said Mr Thiruvoth. “We believe COVID-19 has shown the significance and the long-term effects of ESG factors in business decision-making related to health and safety, employee rights and protection, supply chain alignment, stakeholder management, etc.”
He noted that the ‘S’ in ESG has come into the forefront with a higher scrutiny of corporate response to human capital management and employee rights. While it is true that the world is seeing a massive surge in ESG investing from both individual and institutional investors, “we feel that the adoption of ESG practices in the Middle East insurance industry could take longer and likely to be gradual, unless there is a push from a regulatory angle”, he said.
Amid the pandemic, net inflows into ESG funds in the US reached $21bn in the first half of 2020, nearly equalling the total amount for the entirety of 2019, said Mr Chilmeran citing data from the Morningstar. He said, “COVID-19 has served as the first real proof-point for sustainability, underlining the fact that ESG investing doesn’t come at a cost, but more than that, can future-proof investments and in some cases boost returns, all while helping to shape a better future.”
The pandemic has brought social issues that were not already a priority onto the radar including areas such as occupational health and safety, social safety nets, worker protection, responsible purchasing practices and supply chain issues, as well as diversity and digital rights, including privacy, he added. Also going forward there will be an additional prioritisation of human rights, mental health and healthcare.
Mr Chilmeran said, “During the pandemic period ESG was sidelined considering the additional pressure on short-term business resilience. The crisis has all the more emphasised how ESG factors have remained integral to business resilience and creation of long-term value, yet they have not been very well understood or implemented across the business value chain. The added incentives associated with ESG adoption like positive social impact, additional employee productivity, digitisation initiatives, overall resource efficiency and financial performance should serve as a long-term catalyst for the insurance industry in Middle East.” M