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When we talk about socially responsible – or “sustainable” – investing, what do you envision? Perhaps you think of cleaner air, purer water, renewable energy, replanted forests, or maybe just climate change in general. These are all important to the long-term health of our environment, but truly sustainable investing involves an even wider range of factors, not least for insurance investments.
One industry term for evaluating socially responsible investing is “ESG,” which stands for Environmental, Social and Governance. Several financial firms have already developed their own ESG ratings, scoring methodologies and models, which are intended to measure how a company manages certain risk factors within those three categories. Unfortunately, using differing methods to produce scores makes ratings hard to correlate and compare. To achieve the best results, an insurance carrier that is analyzing ESG scores should choose one rating vendor and not commingle ratings from different sources.
But what are these scores, and what do they reveal? Environmental scores address the kind of concerns that you would probably expect, such as how well carbon emissions are being mitigated. But carbon is only one type of emission being monitored, along with greenhouse gas and toxic air emissions. It might surprise you to know that companies with large data centers need to be concerned about the amount of greenhouse gases they create by keeping computer equipment at the proper temperature. Water efficiency and waste are also under scrutiny from an environmental standpoint.
When it comes to social measurement, it is encouraging to know that the market is insisting on improved corporate cultures. While operational performance, product quality and workplace safety are all critical, additional scores reveal how a company utilizes its human capital. The market will not look kindly upon firms who misuse their people.
For example, when a company is performing poorly overall, one of the first items cut from the budget is training. It makes sense, then, that social risk factors include employee training, as well as employee benefits and levels of diversity and inclusion. Scores in all these areas, when taken as a whole, provide a certain level of insight into how well companies are managing their business.
The governance category is the most frequent and material factor in rating changes, with a special emphasis on a company’s leadership. Investors want to know about the board of directors. What does their aggregate profile look like? Do their qualifications align with the business objectives of the company, and are those objectives sustainable? What is the compensation for the board, and what is the overall ownership and control structure?
Fortunately for insurance carriers, a requirement already exists for the industry’s top business leaders to certify that they are operating with high ethical standards. Now, an ESG measurement will demonstrate how they and other companies compare in this regard.
Additional measurements of impact to and by heat stress, hurricanes, floods and wildfires are also in place. Insurance carriers have the extra unique distinction of obtaining ESG measurements for the businesses that they underwrite, as well as measuring the company itself.
How do ESG scores affect market value and overall return of investments? Today, it’s less true than ever that you must choose between great ESG metrics and great market performance. With that being said, the real focus of ESG score evaluation is on risk management, rather than investment returns. As the concept of ESG scoring and rating evolves, so will the quality and the basis for better corroborating the underlying evidence.