Environmental, social and governance (ESG) principles have risen with astonishing speed to the top of the strategic agendas for senior leaders and boards in insurance. That’s appropriate given the growing importance of ESG ratings to capital markets and the investment community.
There is ongoing uncertainty about the best ways to track the impact of ESG and insurers’ progress toward their goals, as well as its potential impacts on value destruction and creation. In a previous article, we suggested four top-line metrics (including total shareholder return, or TSR) that can act as leading indicators of the efficacy of ESG strategies and help manage perceptual issues that threaten insurers’ value during the next three to 18 months.
To explore ESG’s impact on insurers’ access to capital, EY recently built a database of ESG scores and rankings, with decomposition by sub-sector and history, for the top 100 insurers by market cap, as well as their inclusion into five key ESG indices. Our analysis of that data leads us to conclude that there is a correlation between ratings, inclusion in ESG indices and ESG funds based on these indices and, ultimately, insurers’ stock prices.
In our ongoing dialogue with senior executives across the industry, we hear increasing concern about ESG ratings and their potential impact on investor appetite and share price. These concerns – particularly those about being left out of key indices – are well-founded; a significant number of insurers are currently excluded from key indices due to low ESG ratings.
Multiple agencies, along with research and analytics firms, are issuing ratings and scores to evaluate companies’ exposure to ESG-related risks and readiness to seize ESG opportunities. These ratings and scores are all based on bottom-up evaluations of multiple factors and unique methodologies that align to investors’ long-term performance analytics. There are legitimate concerns about inconsistencies in how these ratings are conferred and the number of different ratings that companies need to monitor. Despite these inherent flaws, analysts, institutional investors and industry bodies are putting increasing weight on ESG scores.
The potential impact is magnified, because assets in sustainable investment products are expected to increase exponentially during the next five years. One of the major barriers to investment in ethical funds – perceived underperformance – appears to be coming down. There is growing evidence that ESG funds and indices outperform, or at least perform on par with, benchmarks.
For C-suite leaders and boards, the most critical question is likely to be: What should be done about these ratings? We believe that the following actions are critical:
- Get fully educated on the rating criteria applied by major agencies, including MSCI, S&P and Moody’s, and how these criteria evolve, as they inevitably will
- Understand index construction for the major agencies and how your equity or bond could be included or excluded
- Identify the “must-have” indices for your company
- Assess your ratings relative to your peer group
- Create a cohesive communication strategy, including a clear storyline and meaningful KPIs, that can be easily shared with and understood by the investor and the analyst community
These steps are urgent, because firms that fall behind, or are perceived to be falling behind, will be punished by the market, with their pool of available investors shrinking over time. Thus, ESG ratings and index inclusion must be immediate-term priorities for C-suite leaders and boards. Collectively, they must craft a cohesive ESG strategy, develop the right KPIs to guide execution and share a clear storyline about their achievements to different stakeholders, including analysts, rating agencies and investors.