Judging Environmental, Social, and Governance Factors in Credit Rating

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August 31, 2018 |

A circular view of planet Earth with green oceans and green icons of modern life elements

There has been a shift in investor expectations in recent years, with shareholders judging companies on a broader spectrum of criteria, rather than solely on financial metrics, according to a new briefing by A.M. Best.

Insurers and reinsurers, with their unique societal role as risk managers, risk carriers, and investors, have not been immune from the trend to adapt and consider environmental, social, and governance (ESG) risks and opportunities in their operations and assess what kind of impact they might have on their credit ratings.

The Best's Briefing, titled "Considering Environmental, Social and Governance Factors from a Credit Rating Perspective," states insurers and reinsurers are facing consumer demands that they take positions on issues ranging from climate change to gender equality. In addition to elevated public interest, companies are under pressure from nongovernment organizations and regulatory authorities, particularly in Europe.

Jessica Botelho, financial analyst, said, "Overall, this shift in focus toward understanding how companies are managing ESG risks and opportunities is not simply a fad that is likely to fade. Moreover, as insurers conduct their business with long-term time horizons, European market leaders in particular have committed to embedding ESG into the cultures of their organizations."

The report states that ESG risks vary by industry and are considered material when it is likely that companies will incur substantial financial costs in connection with them. For insurers, perhaps the most obvious risk is climate change, which has the potential to lead to an increase in the severity and frequency of severe natural catastrophe events. Conversely, ESG opportunities focus on a company's ability to identify and capitalize on relevant challenges for profit, such as developing new products for the renewable energy sector.

With no industrywide ESG standards in place, it can be overwhelming for insurers and reinsurers, particularly small- to medium-sized entities, to understand fully how to implement and disclose ESG practices. Although there has been significant progress in the harmonization of methodologies and standards, further improvements concerning the definition of key metrics and educating users on the importance of ESG in financial analysis are still required.

A complimentary copy of this briefing is available on the A.M. Best website with site login registration.

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August 31, 2018