Much of the discussion about environmental, climate, social and governance issues has been about what costs private business should assume to address them - yet another obstacle to business success. More recently, the conversation has been shifting to â€śsustainable development.â€ť This concept recognizes that some business activities create â€śexternalities,â€ť i.e., social costs not covered in product prices (e.g., pollution) and/or may negatively influence the potential for future generations to have business opportunities (e.g., carbon emission).
Much of the discussion about environmental, climate, social and governance issues has been about what costs private business should assume to address them - yet another obstacle to business success. More recently, the conversation has been shifting to “sustainable development.” This concept recognizes that some business activities create “externalities,” i.e., social costs not covered in product prices (e.g., pollution) and/or may negatively influence the potential for future generations to have business opportunities (e.g., carbon emission).
As government policy, regulation, litigation, protests and other social actions apply pressure to have these issues addressed, business faces an uncertain future and has often adopted a defensive posture. A sustainable development approach suggests that private business strategies account for these considerations, as much for the continued success of the business as for long-term social wellbeing. That is, business improves its knowledge of the issues, contributes to their resolution and in so doing improves business results and contributes to community betterment.
“Sustainable insurance” adopts this approach but has implications far beyond the insurance business. Insurance provides an essential underpinning for economic activity by addressing a wide range of risks businesses face. By understanding and developing solutions for sustainable development, the insurance industry has a broad range of expanding growth opportunities.
The United Nations Principles of Sustainable Insurance
The Principles of Sustainable Insurance (PSI) will be launched at the IIS Annual Seminar in Rio June 17-20, 2012. The PSI were prepared for the United Nations Environmental Programme Financial Initiative by its Insurance Working Group (IWG) (now the UNEP FI Insurance Commission). The UNEP FI Insurance Commission, a group of leading insurance industry institutions, is committed to embedding in industry decision-making environmental, social and governance (ESG) issues relevant to the insurance business, and, more broadly, to sustainable development, through implementation of PSI.
The Origins of Sustainable Development
This effort goes back to the revelations of Rachel Carson’s Silent Spring in 1962. Initially the environmental movement was viewed as anti-business and anti-development. Planning for the United Nations Conference on the Human Environment, held in Stockholm in 1972, many, particularly in the developing world, raised concerns that a focus on the environment would only present obstacles to development, slowing their efforts to catch up to the developed world. The Stockholm event raised awareness of environmental issues and began a process of incorporating them into global development discussions. But the conflicts continued.
In 1987, the World Commission on Environment and Development produced the Brundtland Report titled, “Our Common Future.” This report took a different approach. It proposed that short-term development remain a priority but that it not be at the expense of future generations, i.e., development needed to consider how best to build for a sustainable future. Rather than environmental regulation being simply a cost on and obstacle to development, sustainable risk management would consider costs and benefits of development and a sustainable future as part of strategic management. Thus, for example, the focus on environmental protection rules and sanctions shifts to market pricing mechanisms that account for the “externalities” of environmental degradation.
These ideas were further developed at the Rio Earth Summit in 1992. At the World Summit on Sustainable Development in Johannesburg in 2002, the concept was broadened to include issues of social stability and equity. The United Nations Conference on Sustainable Development, to be held in Rio June 20-22, 2012, dubbed Rio +20 in commemoration of 20 years since the 1992 Rio conference, will showcase further development of sustainable development.
The major Rio +20 themes of a green economy, poverty eradication, intergenerational equity and others, seek to establish an institutional framework for sustainable development.
Insurance and Economic Growth
In a report to the United States Agency for International Development (USAID) by the International Insurance Foundation (IIF), titled “Assessment on How Strengthening the Insurance Industry in Developing Countries Contributes to Economic Growth,” IIF concluded that “1) countries are much more likely to experience sustained growth if their insurance markets develop well; 2) insurance market development is closely related to improved financial sector performance; and 3) insurance markets do not develop adequately without both public and private sector investment in their infrastructure.” (USAID, February 2006)
Among contributions to economic development IIF cites facilitating the provision of credit by helping borrowers and creditors manage credit-related risks, being an important source of long-term finance by mobilizing savings, facilitating investment in infrastructure and high risk/return activities, measuring and managing high-risk exposures, stimulation of debt and equity markets, and using ownership leverage to encourage strong corporate governance and transparency. As insurance industries in developing countries build their skills in risk assessment and management, they transfer this knowledge to their customers to improve risk avoidance and mitigation (e.g., encouraging sound building codes and manufacturing plant safety). The availability of insurance promotes stability. Preconditions for insurance transactions (rule of law, property rights, property registries, monetary stability, political democracy, elimination of corruption) also support broader economic development.
Evidence of the insurance industry’s contribution to economic development includes the fact that insurance consumption not only coincides with national economic growth, it outpaces it, particularly once the preconditions for its development have been established. Economies that have had access to sound insurance services outgrew those that have not. Thus, insurance is an agent, not merely a by-product, of growth. (See USAID, February 2006; “Insurance Development and Economic Growth,” L. Han, D. Li, F. Moshirian and Y Tian, The Geneva Papers on Risk and Insurance – Issues and Practice, 35(2): 183-199 (2010))
Another important catalyst for economic development is the financial sector. Because insurance provides large-scale savings and maintains claim reserve funds for long-term investment, it plays a major role in building stable financial markets. It covers risks that allow credit markets to thrive. It provides risk cost signals to aid risk-adjusted capital allocation. Availability of capital and credit fuels development. The insurance industry maintains risk data that is used to manage risk as economic development unfolds, allowing markets to adjust to changing conditions. As markets grow, and demands for investment get larger, the insurance industry’s concurrent growth supports the higher investment levels. With that investment comes demands for good governance, financial information and transparency.
Sustainable Development and Insurance
Insurance is even more important when environmental, social and governance issues are added to the mix. The combination of risk factors becomes more complex when moving to environmental risk management and sustainable risk management. It is the insurance industry that has the tools to understand and provide innovative solutions to sustainable risk management needs. Enterprise risk management links the various risk types that have long been addressed by insurers, historically in separate functional areas. Environmental, social and governance concerns have become a growing concern and market opportunity. There remain concerns about what other ESG issues can be measured adequately to become insurable risks, but the insurance industry is well-positioned to exploit new market opportunities that will come from the shift of economic development to sustainable development.
The Principles of Responsible Investment
The insurance industry is already engaged in a formal program for addressing ESG issues. Insurers are among the nearly 1,000 institutional investors, investment managers, sovereign and development funds and service providers that are signatories to the Principles of Responsible Investment (PRI). This program was also developed by the UNEP FI and launched in 2006. Signatories are committed to incorporating ESG issues in investment analysis and decision-making, making ESG issues a part of ownership policies, seeking disclosure of ESG risks and responses, promoting broad adoption of PRI, improving PRI implementation and reporting PRI progress. By 2011, PRI signatories represented over 20% of global capital, over US$30 trillion in assets.
The focus of the PRI effort is to make ESG issues a part of fulfilling institutional investor fiduciary obligations to invest in the best interests of their beneficiaries. ESGs are not only a matter of general social concern. An event such as the BP disaster in the Gulf of Mexico not only causes ecological concerns, it affects the financial performance of many businesses that institutional investors rely on that allow them to meet pension and other obligations.
The PRI Institute, charged with Implementing PRI, seeks to make ESG issues a part of the daily activity of investors, sponsoring signatory cooperation on issues such as encouraging security issuers to disclose their greenhouse gas emissions and plans for reduction. It also seeks to improve knowledge on efforts to address indigenous peoples’ rights, to identify and remove cluster munitions, to manage social conflicts, to improve working conditions, to make resource removal sustainable, to make fisheries sustainable, and many other issues that have both social and investment return implications.
In short, the insurance industry has already developed the capacity for supporting sustainable development through its expansion of risk analysis and product development. It has made this more formal through its PRI participation. Now it only needs to continue to expand the scope of risk assessment and innovation in risk management vehicles to meet the needs of sustainable insurance.
The Principles of Sustainable Insurance
From its formation in 2006, the UNEP FI Insurance Working Group set out to better understand the environmental, social and governance factors, and their impact on the insurance industry and sustainable development. They also explored the many industry resources that could be used to address these issues. It was clear that although fragmented, the industry, collectively, had many unique capabilities not available in other sectors of the economy. They drew on the experience and research of many industry employees, academics and other interested parties to formulate a framework of key principles and an approach to their implementation. Their work was supported by a survey of interested parties from over 60 territories. Draft principles have been tested in a series of regional conferences.
The PSI are not merely a corporate vision of lofty platitudes to make the world a better place. They suggest that the insurance industry embrace the ESG issues and sustainable insurance as part of the strategic and operating fabric of day-to-day operations. That is, the PSI call on insurance companies to address ESG issues in risk management, underwriting, product and service development, claims management, sales and marketing and investment. This will bring all of the industry skills areas and innovation potential into the implementation process.
For example, the insurance industry already plays a multifaceted role in global efforts to address climate change. Along with analysis and efforts to find solutions that limit future greenhouse gas emissions, the industry has a role to play in dealing with adaptation to the changes that are in progress from past emissions. For example, losses from coastal windstorms and flooding can be mitigated by a combination of building code changes, underwriting criteria, policy terms and pricing. These tools can increase resistance to and avoidance of natural disaster losses. Public/private initiatives can tap industry knowledge and innovative solutions to increase risk awareness and promote loss avoidance. (See”Tackling Climate Risk: An Insurance Contribution to the COP Discussions,” COP 17 Background Document, The Geneva Association (2011).)
As described in detail by Dan R. Anderson in “Corporate Survival: The Critical Importance of Sustainability Risk Management” (IUniverse, 2005), integration of ESG issues in insurance industry corporate strategies and operations offers a path to long-term survival, with opportunities for growth and market stability along the way.
Join us in Rio June 17-20, 2012 to participate in the launch of the Principles of Sustainable Insurance and learn more about the market opportunities available.
1. How have the economic crisis and aftermath affected insurance lines, e.g., higher claims, decline in sales, growth in sales, new products?
2. How has the experience in financial services affected the direction of insurance regulation? Is insurance regulation affected by mistaken assumptions about industry needs and norms, e,g., excessive restriction on the use of needed hedging facilities?
3. How will the recent experience change risk management practices in the industry?
4. Will problems in the derivatives markets reduce or change the use of capital markets for insurance activities?
5. What new market opportunities are created by the recent crisis?