ESG, Insurance & Insurtech – rebalancing the cost of production and consumption

We operate in a free market that values minimal government regulation. We self-regulate; internally, through company values, manifested in Environment, Social and Governance (ESG) policies, and externally, through the market forces of supply and demand. Much of what we, as a society enjoy in and out of the workplace is credited to our capitalist economic system.

Whilst capitalism is the best we’ve got, data shows there is room for improvement. The cost to third parties (externalities) incurred as a consequence of the production and consumption of goods, is unsustainable. So much so, the existence of no-less-than conscious life itself is at risk. The future can be bright however. ESG is now front and centre in the minds of Directors, Governments and start-up founders.

We use this article to explore ESG as a means to bring the externality profile of production and consumption back into the black. We also explore the critical role of insurance, which has long served society as the leading force in identifying and mitigating risks. Plus, we explore the role of insurtech in expediting these efforts.

 

Laying a foundation for discussion

Fundamentally, corporations exist to create shareholder value. Corporations (in the west) function in a free market where the price and quality of goods are determined by the laws and forces of supply and demand. Corporations in a free market are primarily left to self-regulate.

The production and consumption of goods can result in a cost to a third party e.g. the production and consumption of coal produces carbon emissions. Negative costs to a third party are called negative externalities. ESG policies are used proactively by corporations as a method of self-regulation. The objective of an ESG policy is to aid the corporation in achieving a positive externality profile i.e. in aggregate, not producing a net-cost to third parties.

The role of regulators and authorities in a free market is to intervene reactively if an industry or individual player is producing unacceptable negative externalities, despite self-regulation.

So how are we tracking in our free, self-regulated market? Could we be doing better?

 

Environment

Environmental refers to the impact of the supply chain, goods production and goods consumption on our natural environment.

There is a consensus on climate change and its human cause. Multiple studies published in peer-reviewed scientific journals show that human activities are the primary cause of the observed climate-warming trend over the past century. The vast majority of which comes from the production and consumption of goods. The effects of human-caused global warming are happening now, are irreversible on the timescale of people alive today, and will worsen in the decades to come.

 

Social

Social refers to the way corporations handle their employees, suppliers, customers, and the communities where they operate. This also represents an opportunity for improvement.

Bangladesh still have roughly 4.5 million garment workers who work exhausting long hours, for pay as little as 20 cents per hour. The working conditions are poor, with limited breaks and rampant abuse. Global apparel brands have numerous sweatshops like these across the country.

 

Governance

Governance refers to a corporation’s internal methods and ethics, along with decision making from leadership and how well management and the board attend to the interests of the company’s various stakeholders.

Infamous examples of poor governance practices include; the Facebook-Cambridge Analytica data scandal of 2018 and the 7-11 convenience store franchise enabling franchisee owners to effectively pay their staff as little as 47 cents an hour – which is considered slave labour. Examples like these continue to showcase that a lack of ethics and governance policies means companies are free to put profits over treating people ethically.

 

So why is industry poor at self-regulating?

“The trouble with socialism is socialism. The trouble with capitalism is capitalists.” – Will Schlamm

Whilst capitalism is considered in the west to be the best we’ve got, the quality of capitalism as an economic system is determined by people. Individuals, and the sum of individuals’ actions as a collective.

What determines people’s actions?

Outside of ‘light’ regulation, it is our values. Secondly (a recent development) risk appetite.

 

Values

A corporation’s ESG policy is an expression of the corporation’s values. A corporation is not a sentient being, and as such a corporation can only realise its values through the behaviour of its people. People’s values should answer this key question –

What externality profile are we willing to inflict in order to create shareholder value?

ESG is a values-based decision. Industry has failed the values test over the past century, choosing profits over environment, social and governance.

 

Risk Appetite

Many corporations are being forced to adopt an improved externality profile given the risks posed to corporations and their directors. Risks include; restricted access to financing, reduced participation from new investors, alienating consumers and legal action.

The average corporation’s risk appetite statement has escalated ESG risks to a ‘low tolerance’ status, meaning mitigative action is critical.

 

The role of insurance and insurtech

To effectively manage a corporation’s externality profile is to apply a risk management framework with a focus on the cost to third parties resulting from the production and consumption of goods. Example:

‘The insurance industry has long been at the vanguard of understanding and managing risk and has served as an important early warning system for society by amplifying risk signals. Through loss prevention and mitigation, by sharing risks over many shoulders, and as major investors, the insurance industry has protected society, shaped markets, and underpinned economic development. Today, the risk landscape is rapidly evolving, spawning new and complex risks that threaten our increasingly scarce nature-based assets and undermine our common future.

The insurance industry plays a fundamental role in sustainable development, which is not a choice, but the only option. And the message is loud and clear – insurers are communicating strong risk signals stemming from a wide range of environmental, social and governance issues – from climate change, biodiversity loss and ecosystem degradation and water scarcity, to poverty, emerging manmade health risks, ageing populations, child labour and corruption’

– Achim Steiner, United Nations, Under-Secretary-General and Executive Director, United Nations Environment Programme.

Emerging risks can be challenging to transfer, as the insurance industry relies on historical data to price and set terms. Insurtech players are pouncing on opportunities to broaden risk transfer options for consumers through the use of data science techniques.

These are two Gateway portfolio companies that trailblazing the concept of using insurtech to revolutionise big world problems:

IBISA – bring resilience and security to global food supply chains and add social value to farmers and their families.
500m farmers in third world nations supply food for >2bn people. >90% of which is uninsured.
Its always been cost prohibitive to distribute insurance in these regions and to assess claims, especially when you’re looking at $15 premiums for $1k cover. IBISA have fixed the economics. Digital distribution tech for local mutual and remote sensing data (satellites) for parametric style claims settlements. In addition to the social good and underwriting food supply chains, its helping to augment the insurance premium pool.

KITA – The world’s first carbon insurer. Carbon credit markets rely on the sellers of carbon credits to come good on the delivery of carbon reduction schemes. This sometimes does not happen, e.g. fall short on the number of trees planted, or the number of carbon captured by a forest is compromised by a bushfire. KITA removes the ‘carbon delivery risk’ from buyers and sellers in the market.

Ultimately, Insurtech has a meaningful role to play that can be the key to rebalancing the externality profile of industry. Insurtech is helping to connect risk capital with new and previously uninsurable risks, and in-turn reducing the protection gap. It is providing better early warning systems and natural catastrophe propagation mapping to drive smarter loss prevention and stronger resilience.

Insurance and insurtech will continue to be global leaders by redefining a standard that promotes the importance of acting ethically, mitigating the environmental impacts of company actions and policies, and ensuring companies are committed to providing a safe and thriving environment that prioritises people and planet in-line with shareholder value.

To learn more about how Insurtech can help drive change by utilising ESG practices, register now to our first Insurtech Gateway event of the year. At this event, we partner with Insurtech Australia and Envest to discuss the topic further with the following key speakers: Binuo Erth, Tobias Grimm ,Simon O’Dell, Nicholas Martin and Jacki Johnson.

 

References

Corporate Honesty and Climate Change: Time to Own Up and Act

Climate change: Top companies exaggerating their progress – study

Economy Versus Environment: How Corporate Actors Harm Both

Corporations and the Environment

7-Eleven worker was paid 47 cents an hour in case lawyers call ‘slavery’

What is the “G” in ESG?

Who is really to blame for climate change?

State of Climate in 2021: Extreme events and major impacts

Scientific Consensus: Earth’s Climate Is Warming

World Counts Sweatshop Facts