Companies’ sustainable investments and commitments have the potential to reshape their risk profiles in D&O, E&O, and EPL, among other areas.
Published on April 15, 2022
By Jim Proferes, Global Executive Underwriting Officer, Professional Liability
Environmental, social, and governance (ESG) considerations are having an ever-increasing impact on the ways in which companies invest for the future and on their public commitments to do business sustainably. As companies in multiple sectors expand their ESG profiles, disclose their risks, and declare their commitments in this area, their investments and statements could potentially have important implications for their risk profiles, including in the area of professional liability.
Fueling much of this activity is strong and growing interest in sustainable investment. According to one estimate, assets under management in funds that abide by ESG principles surpassed $1 trillion for the first time on record.1 There is also increasing recognition that in many sectors, companies’ ability to position themselves as environmental leaders is helpful in attracting investor interest. This was evidenced when during late 2021, Tesla’s market capitalization surpassed the collective market capitalization of five of its leading rivals.2 This trend is being reinforced by comments from major funds like BlackRock, which have put increasing pressure on companies to outline their ESG-related commitments moving forward.3
As companies invest for the future, their assessment of the ESG-related risks confronting their businesses is growing as well. S&P Global Market Intelligence has reported that 80 percent of the world’s largest companies are reporting exposure to physical or market transition risks associated with climate change.4 And there is also a clearer focus on the degree to which companies’ stated ESG-related commitments are in line with reality. For example, by October 2020, eight breach of fiduciary duty shareholder derivative lawsuits were filed against the boards of major corporations for allegedly failing to live up to their diversity commitment disclosures.5 In April 2021, the Securities and Exchange Commission (SEC) issued a risk alert related to recent examinations of investment companies, focusing on potential gaps in internal controls and on potentially misleading claims regarding ESG products and services.6 Finally, in March 2022, the SEC issued proposed rules for climate-related disclosures to investors.7
"As companies invest for the future, their assessment of the ESG-related risks confronting their businesses is growing as well."
All of these developments have implications for professional liability, an area of coverage where the insurance industry is increasingly working to help its clients identify and manage ESG-related risks. Here are a few sub-topics within the broad discussion on ESG that could impact the professional liability coverages the industry provides.
In the area of directors and officers (D&O) insurance, several areas bear examining:
- Companies’ disclosures on their direct ESG profiles that are in advance of, or in response to, issues raised by regulatory authorities and advocacy groups.
- Companies’ review and disclosure on their indirect ESG profiles that are related to their relationships with suppliers and their business value chain down to customers utilizing their products or services, commonly referred to as Scope 3 emissions disclosure.
- Companies’ transition risk in evolving their operations to a more environmentally sustainable business, which could lead to stranded assets that add material financial risks.
- Investments in new businesses or capital projects that are rapidly emerging to provide and/or support green energy and sustainable resources and services, even though historically there have been significant volatility and above-average failure rates in rapidly emerging technologies and services.
In the area of errors and omissions (E&O) insurance, risks could arise for the professional services advisors that are guiding clients through this significant period of transition, which may include new regulations and higher risk of failure. Such considerations apply to law firms, accounting firms, consulting firms, and architectural and engineering (A&E) firms, among others. The same holds true for private equity, venture capital, banking, and investment firms providing professional services tied to strategy, such as mergers and acquisitions and the raising of capital.
The area of employment practices liability (EPL) will also be affected by an era of greater employee activism in areas such as pay equity, diversity and workplace environment challenges and opportunities. Several recent examples have included the ways in which companies have responded to COVID-19, including work-from-home flexibility and managing through the #MeToo movement and the Black Lives Matter movement.
"As insurers, brokers and agents, and risk managers work together to fully understand companies’ ESG-related planning process, there will be a sharp focus on company risk disclosures as well as progress toward ESG targets as represented to regulators, investors, and employees."
As briefly mentioned earlier, the financial services industry will be integral in funding a number of dimensions of ESG-related change, particularly in the area of climate change. Accordingly, this sector could potentially face growing risk, particularly from the extraordinary rise in ESG and “sustainable investment” products that have surged in the past few years. What disclosure requirements will arise regarding funds’ stated long-term objectives versus actual portfolio performance? How will such firms’ fund fee structures align with large-cap or mid-cap benchmark measures? Risks could also arise for banking, private equity, and venture capital firms as they manage their operations in an era when advocacy groups are increasingly pressing for “sustainable finance” practices in lending and investing, including steering away from sectors that may be viewed as heavy in carbon emissions.
This list of potential professional liability risks related to ESG is by no means exhaustive: Other important areas include fiduciary liability and transactional liability coverage. In all these areas, however, one constant is that the insurance industry is clearly committed to supporting its clients’ transition toward ESG compliance and ESG-related opportunities. And given the fact that ESG also brings a new level of risk, new approaches will have to be incorporated into managing professional liability coverages.
Underwriting is rapidly evolving to focus on the emerging risks and opportunities. As insurers, brokers and agents, and risk managers work together to fully understand companies’ ESG-related planning process, there will be a sharp focus on company risk disclosures as well as progress toward ESG targets as represented to regulators, investors, and employees.
As the trends in this space continue to take shape, corporate risk managers will seek to stay abreast of them and will increasingly look to their insurance providers and advisors to help them assure that their existing coverage addresses these new dimensions of ESG-related risk. This is a challenge professional liability insurers are ready to embrace and support.
1 “Sustainable investment funds just surpassed $1 trillion for the first time on record,” CNBC, Aug. 11, 2020. cnbc.com/2020/08/11/coronavirus-esg-and-sustainable-funds-surpass-1-trillion-for-the-first-time.html
2 “Factbox: Tesla market cap eclipses that of top 5 rival carmakers combined,” Reuters, Oct. 26, 2021. reuters.com/business/autos-transportation/tesla-market-cap-eclipses-that-top-5-rival-carmakers-combined-2021-10-26/
3 “Larry Fink’s 2022 Letter to CEOs: The Power of Capitalism,” Blackrock, Jan. 18, 2022. blackrock.com/corporate/investor-relations/larry-fink-ceo-letter
4 “Accounting for Climate: The Next Frontier in ESG,” S&P Global, Oct. 1, 2019. spglobal.com/en/research-insights/featured/accounting-for-climate-the-next-frontier-in-esg
5 Bethan Moorcroft, “ESG challenges growing more important for boards of directors,” Insurance Business, Jan. 5, 2021. insurancebusinessmag.com/us/news/professional-liability/esg-challenges-growing-more-important-for-boards-of-directors-242739.aspx
6 “The Division of Examinations’ Review of ESG Investing,” US Securities and Exchange Commission risk alert, Apr. 9, 2021. sec.gov/files/esg-risk-alert.pdf
7 “SEC Proposes Rules to Enhance and Standardize Climate-Related Disclosures for Investors,” US Securities and Exchange Commission press release, Mar. 21, 2022. sec.gov/news/press-release/2022-46