Captives must grasp ESG – or put their own usefulness at risk
Sustainability and ESG (environmental, social and governance) principles have permeated the insurance industry, the wider financial system and most large corporates, meaning captives must also understand the implications for them.
Damian Payiatakis, Head of Sustainable and Impact Investing, Barclays, explains: “ESG and sustainability are rapidly evolving and sometimes complex concepts. They are also now moving up the agenda of the risk-transfer industry. Captive managers who fail to take them seriously may face higher costs and avoidable risks.
“Moreover, they may miss an opportunity to ultimately fulfil their underlying purpose to reduce the company’s total cost of risk. Captives should think about sustainability not simply as an investment topic, but as a framework to improve risk management throughout their activities.”
James Larkin, global head of Captive Insurance, Barclays, agreed noting that while sentiment on how parents use captives changes over time, for example due to economic conditions and rates in the traditional markets, ESG offers the sector a new way to become relevant in the long term.
“Embracing sustainability can help captives be both more important to, and innovative for, their owners,” he said. “For example, as corporates grapple with climate change there are huge implications around the risks they will face.
“We’re talking more and more to our captive clients about ESG alongside our industry colleagues who are speaking to parents about the same topics. How they can manage sustainability risks and engage with their parent companies to de-risk their business, as well as to make a difference in the wider world.”
Payiatakis explained three key ways that captives can incorporate sustainability principles to become more valuable to their owners.
The first relates to how they invest. While sustainable investing, in line with ESG principles, is increasingly well established, Payiatakis suggests captives can enhance and sharpen their practice. This could include reviewing existing managers for ESG capabilities or updating investment guidelines to incorporate sustainability objectives as well as expanding the range of sustainable investments they use.
The second relates to improving underwriting as well as risk transfer policies and guidelines. Captives can incorporate ESG considerations to get a better grasp of the risks and exposures they are taking. This can extend into topics such as cyber, climate change or residual values on assets. Furthermore, as commercial insurers incorporate ESG factors into their decision-making and pricing, captives also need to understand them to accurately cost risks or re-insurance.
The third relates to proactively de-risking the parent company, rather than simply analysing risks and accruing for potential costs. Captives can help parents understand their overall risk profile, and pre-emptively mitigate specific risks to reduce the probability or severity of potential claims. They may also look to use its capital or bursary as positive intervention.
“This could mean funding internal initiatives that reduce the parent company’s likelihood of exposure to those risks, or investing in external opportunities that address the broader issue,” Payiatakis said.
“For example, rather than solely insure against risk of slavery in the supply chains, captives could fund initiatives to provide the parent greater transparency. More ambitiously, they could go as far as making a strategic investment in ventures providing solutions to the parent around those issues.
Alternatively, the experts note that buildings that do not meet green standards will likely face higher premiums in the future. Captives could help fund programmes now that install renewable energy or energy efficiency measures. This not only supports the captives’ role in reducing risks and costs, it also supports the parent company’s likely net zero ambitions.
For captive managers who can spot it, there’s a valuable link between sustainability and risk management. Managers sometimes benefit from an external perspective to see the opportunities, as it requires looking in a broader, more holistic way.”
The pair stressed the growing importance of sustainability to the industry. A good example of this approach being formalised can be seen in the Insurance ESG Framework unveiled by Guernsey earlier this year; an initiative which perhaps inevitably other regulators will mirror.
They suggest captives could get ahead of the changes and see this as an opportunity rather than a challenge.
Larkin predicts: “It won’t be long before we are seeing fines from regulators based around not accounting for these risks. Reputational damage is just one of the many risks companies are facing if they don’t take ESG seriously at board level.
“Captives have feet in two camps that are rapidly embracing ESG – the insurance industry and their corporate parents. Speaking to our colleagues in both these markets, we can see growing pressure from both sides for captive managers to understand and address these topics.”
Payiatakis concurs, but believes captives have more fundamental reasons to adopt more ESG activity. He stresses that their very nature is to help their parent make better decisions, reduce risks and provide good governance around the risk management process.
“At the very heart of sustainability is the question ‘How do we meet the needs of today without compromising the ability of future generations to meet their own needs?’ A captive helps its parent manage current financial and reputational risks so that their parent is viable in the future. If anything, sustainability should allow captives to enhance their reputation and educate stakeholders on the important role they serve.
“It’s about much more than investments and even risk management – captives can fulfil their role around a parent’s sustainability in a much deeper sense.”
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