How Captives Support ESG Considerations

Businessman holding the acronym ESG in a bubble with adjoining bubbles reading environmental, social, and governance

Anne M. Towle , Alex Gedge | July 26, 2023 |

Businessman holding the acronym ESG in a bubble with adjoining bubbles reading environmental, social, and governance

Editor's Note:  Hylant Global Captive Solutions contributes this Thought Leadership article examining ways captive insurance can assist organizations with their environmental, social, and governance (ESG) initiatives.

Environmental, social, and governance (ESG) initiatives are increasingly common among corporations worldwide. Adopting ESG policies has allowed many companies to formalize commitments they've made to be better corporate citizens. In other cases, such as the EU ESG Regulatory Regime, companies have been given a framework to pay closer attention to these issues as stakeholders demand greater corporate responsibility and disclosure of ESG data activities related to internal policies surrounding these issues.

Companies with effective ESG programs ensure their philosophies are imbued throughout every aspect of the organization, and their captive insurance programs are no exception. In fact, captives can play multiple roles in supporting ESG activities and helping companies make strategic decisions.

Captives related to ESG objectives provide an opportunity to take a fresh look at how a business is operating and improve management's ability to identify and analyze risks that may not have previously been obvious. For example, taking a deeper dive into how environmental factors may create risks to property or operations often pinpoints areas management may not have considered, such as the impact a distant typhoon might have upon a supplier's ability to deliver critical components.

Companies that have embraced ESG policies and that also use captives to cover risks need to take a closer look at how funds for those captives are invested. Captives should not invest in other companies whose values are inconsistent with those of the parent company.

ESG policies tend to be more well established and formal in European markets than in North America. Companies doing business in the European Union and the United Kingdom must look beyond their own internal objectives to ensure their captives comply with local requirements related to ESG issues. And, as more of those local laws appear, captives may offer a way to protect against unexpected fines or other compliance-related costs.

Some companies use an ESG focus in their captives to support policies they hope will spur social change. For example, when companies committed to diversity, equity, and inclusion (DEI) use their captives to simultaneously protect their risks in those areas and invest premium dollars in companies supportive of DEI, they help advance their causes. At the same time, the increased focus that comes with exploring risks provides an opportunity to adjust internal policies and procedures to better educate employees and improve practices.

As awareness of specific ESG risks increases, captives allow companies to respond. A great example is environmental risks, which continue to climb in importance, according to the Swiss Re risk register. Companies may find it cost-prohibitive to obtain commercial coverage for a risk they've identified. Using a captive affords the flexibility to cover that exposure directly by transferring it to reinsurance markets, devising an alternative risk management solution such as parametric coverage triggered by easily measured factors such as rainfall or wind speed.

Captives are particularly suitable for tracking a company's changing risk profile when it comes to environmental risks. That's especially true for companies moving in and out of large projects, such as commercial construction businesses. The focus and use of the captive can adapt to the projects' life cycles.

The heart of every successful captive is data, and that's true when adverse weather is a factor in potential claims, delays, or other issues. Studying historical data can uncover situations where risk increases, and the captive can step in to address it. Of course, not every risk can be anticipated, such as the impact wildfires in Quebec recently exerted upon the ability of New Yorkers to do business. Although a "smoke" policy per se isn't practical, when you're attempting to identify potential environmental risks, it's better to think broadly, because some events will truly be unexpected.

Even specific captive practices can advance corporate ESG objectives. As an example, a company focused on minimizing its carbon footprint might limit the number of in-person meetings needed to manage the captive's operations. The company might also choose a domicile where carbon reduction efforts are supported.

Governance is critical. If you've decided to invest in your company's own insurer, you want to make sure it's being operated legally and as efficiently as possible. The board and other leaders must operate by ethical and efficient governance practices, including diligent regulatory compliance. If leadership embraces DEI, the captive's board and other decision-makers, as well as advisers and vendors, should reflect the community as much as possible. Fortunately, entrants to the captive universe have access to a wealth of best practices about what makes an effective board and efficient captive management.

Furthermore, companies are considering their partner's ESG policies. Captives will typically work with multiple service providers and partners, all of whom should be able to demonstrate their commitment to ESG policies. An example would be the Sustainable Finance Disclosure Regulation, which requires investment firms to publish risk analysis and disclosures down to products offered. Captives can highlight a parent company's ESG policies through the policies of the subsequent partners and service providers with whom they work.

Captives and ESG priorities complement each other in multiple ways. Whether the captive is being used to protect the company's well-being from risks related to ESG's three categories, or whether you're choosing to live out your corporate commitment through your risk management approach, captives provide the flexibility to ensure you sleep soundly in an ever-more-complex world.

Anne M. Towle , Alex Gedge | July 26, 2023