Greg Lang, RAIN
23 November 2022ArticleAsset management analysis

Net zero: ESG not delivering as promised

In 2020, a group of European insurers gathered for an industry first to discuss how carbon footprinting could be applied to underwriting. In 2021, the Net-Zero Insurance Alliance (NZIA) was created. The NZIA is a United Nations-backed initiative to help the insurance industry transition to a low carbon economy.

The group is made up of insurers representing 12 percent of the world’s insurance premiums. They have committed to transitioning their insurance and reinsurance underwriting to net zero greenhouse gas emissions by 2050. Today, in 2022, you can’t pick up an industry publication or attend an industry conference without reading about environmental, social and corporate governance (ESG) agendas.

For many, ESG and ESG investing focuses on the E—environmental, issues such as climate change and resource scarcity—but the acronym obviously means much more. It also covers social and corporate governance issues. The concept is solid. However, in practice, significant social and legal issues are being raised/created by some of these same social and sustainability initiatives: risk exposures that insurers and insureds need to consider. My clients are starting to ask about putting these exposures in their captives. ESG may be doing more harm than good.

Trillions of dollars have poured into so-called ESG funds in recent years. Bloomberg projects more than one-third of global managed assets could be ESG by 2025. Notwithstanding, there is little evidence of tangible benefit. The ESG promise is that you can do well and do good at the same time, but studies from UCLA and NYU have shown that ESG funds have underperformed the broader market by more than 250 basis points. It’s not just about the returns though, right? Did my investment loss ultimately do good? Unfortunately, no.

Researchers from universities of Utah, Miami, and Hong Kong wrote a paper in May 2021 titled “Does Socially Responsible Investing Change Firm Behavior?”. The study found there was no evidence that socially responsible investing improves corporate behaviour. The report selected firms focused on lowering pollution, board diversity, high employee satisfaction and better workplace safety.

The results suggest that funds investing in these companies are not “greenwashing”, but they are “impact washing”. They invest in a portfolio consistent with their objectives, but they do not try to impact corporate conduct.

Greenwashing is disinformation disseminated by an organisation to present an environmentally responsible public image. Recycling bins in a cafeteria is an example of corporate greenwash. The effort is not very effective. We should eliminate plastic, not just recycle. Impact washing is when fund managers or bond issuers overstate or falsely claim an investment’s positive impact on the environment or society. The paper was updated in September. The results did not change.

This is not really surprising. The same outcomes have been written about for years, regarding investors’ avoidance of “sin stocks” such as alcohol, tobacco, firearms, pornography, and gambling.

ESG and anti-sin investing fail for the same reason. Divesture of investment raises the return of the investors who remain. It also removes investors/activists who might fight for reform. Products and services that can be legally bought and profitably sold will be. This is true no matter how much someone disapproves of them.

Sports gambling and cannabis are not even legal in some places and look how successful these “sin” products have become. Pro-sport franchises and state controllers can’t embrace them fast enough. The production of goods and services declines only when folks stop buying—not when people stop investing.

What needs to change?

ESG funds need to report on more than just financial results. Reports should highlight the sustainability benefits companies create that would not have occurred otherwise. Have you ever read the fine print from one of the popular sustainable investment funds? Me neither, until I started doing research for this article.

“There is no guarantee that any fund will exhibit positive or favourable sustainability characteristics” is a popular one. Right up there with “past performance is no indication of future results”. If ESG funds can’t be expected to deliver ESG benefits, why call yourself ESG?

There also needs to be a better system to compare corporate social responsibility. Many companies carry ESG scores or ratings. The top ESG rating agencies include Sustainalytics, MSCI ES Research and ESGI. The intention of an ESG score is much like a credit rating from S&P, Moody’s or Fitch, but unlike credit ratings, which are consistent across agencies, ESG ratings often vary.

The criteria for ESG rating need to be standardised. It’s difficult to compare ESG ratings across industries. What if an electric car company you want to invest in has a higher ESG score than a fast-food franchise? For ESG, lower is better.

Are $25 dollar wages and recycled fryer oil more important than obesity concerns? How valued is carbon-free driving compared to the added cost that puts electric cars out of reach for most consumers? What about the environmental impact of the mining required to make batteries and later disposing of them? Shouldn’t that impact a company’s ESG metrics even if they don’t make the batteries?

What if that same manufacturer enters the battery business to reduce manufacturing cost as well as battery production/disposal pollution? Its ESG score will surely go up. Is that a bad thing? It’s complicated and getting more so.

ESG and fiduciary responsibility

In August 2022, 19 attorneys general (AGs) wrote a letter to BlackRock’s chief executive officer Larry Fink. They warned that BlackRock’s ESG investment policies appear to violate the sole interest rule and other legal investment principles. The sole interest rule requires investment fiduciaries to act to maximise financial returns, not to promote social and political objectives.

The letter points to several comments BlackRock has made that the AGs say “indicate BlackRock has already committed to accelerate net zero emissions across all of its assets regardless of client wishes”.

Blackrock defended itself with a letter from the company’s head of external affairs stating: “BlackRock does not boycott energy companies or any other sector or industry” and insisted that “the company’s engagement and voting around climate risk does not require companies to meet specific emission standards”

BlackRock’s letter defending itself prompted New York City Controller Brad Lander to send Fink a letter accusing BlackRock of not following through with its ESG commitments. Lander’s letter to Fink states that BlackRock “has repeatedly and rightly recognised climate change as an investment risk”. Lander’s letter goes on to say: “The fundamental contradiction between BlackRock’s statements and actions is alarming.”

States such as NY, NJ and CA are major BlackRock clients. Pressing a social agenda on companies may serve BlackRock’s interest attracting states’ capital but doesn’t mean these commitments are in the best interest of shareholders. At the very least, we can see the potential for conflict. It will be interesting to see how this plays out.

Where have all the insurers gone?

In March 1986 Time magazine’s front page read: “Sorry America. Your insurance has been cancelled.” The insurance industry was in the midst of a liability crisis—the problem was runaway juries. Lay people were being allowed to determine complex liability cases and award punitive as well as pain and suffering damages. Thirty percent contingency fees for lawyers provided incentives for the situation to get out of hand. There is a new crisis on the horizon.

Insurers, brokers and select service providers continue to tighten underwriting, service and investment policies to exclude polluting and “sin” industries from their client lists. Munich Re has stated on its website that as of April 2023, it would not invest or insure projects involving new oil and gas fields or new midstream oil infrastructure. Several major brokers have less publicly refused to assist insureds who operate anywhere in the cannabis space or insureds involved in the manufacture or distribution of guns. Where will these industries turn for help? I have strong suspicion I know the answer.

Nothing new for big oil

Everen was formed in 1972 by 16 energy companies after the traditional insurance market turned its back in response to two large industry accidents that occurred in the late 1960s: an oil spill in CA and a refinery explosion in LA. Everen Specialty, previously known as Oil Casualty, was formed during the before-mentioned liability crisis of 1986 when commercial insurers ceased to provide adequate D&O coverage and excess liability insurance for energy risk.

The alternative market has served the energy industry for a long time. I don’t think it will be very long before we see an ESG alternative mutual or gun manufacturers’ risk retention group popping up at captive insurance conferences. I for one stand by ready to help.

Greg Lang is the founder of the Reinsurance and Insurance Network (RAIN). He can be contacted at: