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Defining the right metrics to track ESG progress in insurance

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Environmental, social and governance (ESG) issues have moved to the forefront of the board and C-suite agenda far more quickly than many insurance leaders anticipated. The acceleration has been driven by a “perfect storm” of social issues, market and macroeconomic conditions, environmental threats and political and regulatory developments. The scope and complexity of ESG – which presents huge opportunities alongside significant risks – require insurers to both develop holistic long-term strategies and prioritize pragmatic near-term action.

In light of growing pressure to act, board and C-suite attention is turning to pragmatic steps that can help minimize downside risks and maximize upside potential. One of the most critical steps is to determine the right metrics to measure the impact of ESG policies and strategies and to track performance toward key goals and relative to peers.

We believe the four following metrics reflect some of the most immediate risks associated with climate change and the broader environmental agenda:

Total shareholder return (TSR)

ESG ratings given by equity analysts are a top concern for insurers. There are significant and justified concerns associated with the inconsistencies in how these ratings are conferred and their potential impact on share price and investor appetite. Many insurers fear that bad or even mediocre ratings will lead to stock price depreciation as more institutional investors adopt stricter ESG investment policies.

Strong ESG ratings are critical for inclusion in ESG index inclusion (e.g., DJSI, MSCI), which typically leads to higher stock prices. As more investors introduce ESG criteria into their portfolio management strategies, demand and supply will drive up share prices of the firms that meet the criteria. Thus, over the short and medium terms, share price performance will become a good measure of how well individual insurers execute their ESG strategies and tell their ESG stories.

Brand value

Brand value may be the ultimate long-term-value metric, with direct positive correlation to shareholder value. Strong brands are built strategically, in the form of positive associations and perceptions (e.g., trust and confidence) among investors, customers and employees. These attributes translate into strong financial performance and pricing power. While brands are often considered “soft” metrics, they are nevertheless measurable and will become more important to tracking value in the age of ESG.

In the insurance sector, brands have typically emphasized perceptions of financial strength, stability and longevity. ESG principles, including transparency and accountability, can be excellent complements to traditional positioning. Conversely, brands that don’t demonstrate a credible commitment to a greener economy, diverse workforces, ethical business practices and a more equitable society may see decreased favorability ratings and lower financial value. In other words, damaged brands can make stock prices fall.

Economic net worth (ENW)

ENW growth over time provides a good barometer on whether a firm is adding to its long-term value or depleting it. However, ESG considerations are causing important changes in the risk and return profile on both the asset and liability sides; therefore, we expect that the approach to evaluation will evolve even further.

For both assets and liabilities, firms should take stock of the way they measure their current values to reflect the fact that risk profiles and future expectations are changing in response to climate action. They can use this insight to communicate a robust assessment of their current ENW. They should also look to quickly embed new data, assumptions and valuation techniques related to green assets and liabilities into their ENW frameworks.

Return on capital (ROC)

ROC effectively measures the ability to underwrite, price and manage risk effectively to generate positive returns. Many insurers already have sophisticated risk modeling, often mandated by regulatory standards, and perform stress tests to ensure they are adequately capitalized.

There is growing momentum to include both physical and transition risks of climate change in insurers’ capital models, as well as regulatory moves toward more extensive climate scenario testing. As data on climate impacts evolves, we expect ROC to become an important indicator of insurers’ ability to manage its exposure.

We believe these metrics represent accurate barometers of exposure to climate-related risks and perceptual issues that threaten insurers’ value in the near term. These metrics also work well because they are:

  • Pragmatic and practicable
  • Universally accepted
  • Already tracked and reported by some insurers
  • Often signed off in standard audit procedures

They can also be decomposed into sub-metrics to enable root-and-branch analyses, support mapping to non-financial metrics, and provide line-of-site to different stakeholder groups.

While it’s good news that much of what insurers already track – mainly financial metrics – will be useful in measuring long-term value, some dissonance must be managed. After all, the industry’s financial metrics have evolved over 100+ years and are well established and generally comparable across carriers. ESG data, on the other hand, is only recently developed and non-standardized across firms. We see the disparity as a reason for the industry to proactively engage in defining the right metrics and providing the right context, rather than taking a minimalist, “tick-the-box” approach.

Read more on EY.

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