Wednesday, July 24, 2024

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ESG – what is the impact of captives?

Dr Eberhard Witthoff is an independent expert and experienced senior executive for Claims Management and Risk Management. His main interest is to advise on the topics Climate Change and ESG risk and (re)insurance by bringing together operational insurance expertise and technological innovation. He has been Head of Claims at Munich Re since 2016 for the Global Clients and the region Asia-Pacific with a worldwide responsibility for Casualty and Cyber claims until his retirement end of 2022. Previously he was from 2005 Head of Claims for Germany and Central Eastern Europe and from 2007 to 2016 the Head of Claims for the regions Asia-Pacific and Africa. Before joining Munich Re in 1997 Eberhard began his career as an insurance and contract lawyer in a law firm in Munich serving clients worldwide.
John Morrey started his career in 1985 working for the reinsurance subsidiary of a large UK composite insurer in Lime Street, London. In 1989 he moved to Brussels to assist in the setting up of the European branch operation for the same reinsurer and ultimately became the Branch Manager. In 2002 he had the opportunity to work in Luxembourg for the Stonefort Group (one of Luxembourg’s largest captive insurance groups) where he acted as CEO until his retirement in mid-2023. He famously took Stonefort Group from a few files in a cardboard box to a team of 50+ people with over $1B in cumulated results and maintained an AM Best A- rating. In his retirement, John is maintaining his interest in the industry by digging down into important market developments such as ESG and working generally on good governance.

Corporate Social Responsibility (CSR) or now better known under the label “ESG“ is a topic that has long preoccupied the insurance industry. However, it has historically been more than just a green business trend or a voluntary commitment to the environment and human rights.

As part of the European Green Deal adopted in December 2019, tough regulatory requirements have been introduced by the EU. The Corporate Sustainability Reporting Directive (CSRD), for which the reporting standards were developed last year culminating in the European Sustainability Reporting Standards (ESRS), should be mentioned here in particular.

Equally important is the Sustainability Financial Disclosure Regulation (SFDR), which deals with the sustainability impact of financial products and regulates the extent to which financial products are ESG compliant. Finally, the EU taxonomy has created an overarching set of rules that establish the technical criteria according to which the sustainability of economic activities is assessed.

All of these rules apply to the European insurance industry and, by extension, also to captives in Europe. But even this is not the end of the story; regulation remains dynamic and is constantly being supplemented or even expanded, such as with the proposed Corporate Sustainability Due Diligence Directive (CSDDD).

Global relevance

Does all this legislation mean that ESG is now a purely European affair? Not at all: ESG regulation has become firmly established in the majority of Western countries, including those outside the EU.

In the USA, despite a heated political-ideological debate surrounding ESG criteria, the SEC has taken proactive steps to implement ESG reporting criteria. Individual states such as California have also developed their own ESG legislation.

In the UK, the FSA has actively addressed the ESG issue through a series of regulations, emphasizing the importance of transparency. The influence of ESG extends to all sectors of the global economy, including the insurance industry, impacting core business practices such as risk management and investment strategies as asset owners.

How can captives adapt to this new reality? The ESG regulatory framework as a whole is initially quite intricate and confusing. The European Sustainability Reporting Standards (ESRS) alone encompass over a thousand data points and 12 standards that must be considered in reporting.

It is a real challenge to have a comprehensive understanding here, as there are numerous interdependencies and references between the regulations. The delineation of individual areas, the breadth of topics to be addressed, and the somewhat vague terminology pose a significant challenge for all concerned companies.

Unfortunately, that’s not all: it becomes quickly evident that neglecting compliance with ESG can lead to increased reputational risks. Even the liability risk for board members who are responsible for ESG matters will likely rise, as highlighted by the latest draft of the CSDDD, and taking into account the increasing number of lawsuits related to greenwashing or climate change. Nevertheless, all of this does not have to result in a corporate compliance drama.

With a strategic and structured approach, ESG issues can be addressed systematically, eliminating the temptation to dive into random initiatives. Our focus here should be on seven areas:

1. Buy-in of Top Management

The success of any ESG strategy and performance will be closely tied to the proactive leadership of top management. It’s not merely about assigning responsibilities and offering passive support, but rather about genuinely championing this strategy.

Board members, in particular, are tasked with creating robust reporting structures and actively promoting the transparency required by regulations. Not only does this serve the company’s best interests, but it also shields them from potential liabilities.

Consequently, managers play a pivotal role in driving the organisation’s commitment to ESG. This becomes even more significant as ESG is expected to impact the existing business model, giving rise to a separate KPI system alongside financial indicators.

2. Strategic Value

It’s not a question of devising an entirely new strategy, but rather expanding the current one. This involves defining vision, ambitious goal-setting, resource allocation, and prioritisation within an ESG context.

For instance, outlining how the company will enhance its ESG performance over time and successfully undergo a business model transformation. The foundational principles of sustainable insurance can serve as a starting point for captives.

Focusing on the core principle of double materiality is crucial. In addition to knowledge of the regulatory requirements, content guidelines such as the Global Resource Institute (GRI), Task Force on Climate-related Financial Disclosures (TCFD) or Task Force on Nature-related Financial Disclosure (TNFD) are a useful addition to the development of the strategy.

Finally, the stakeholder approach and dialogue should also be part of the strategy, as the issue of stakeholder involvement, both internally and externally, is central to the capturing of all ESG factors.

3. Alignment with the Value Chain and Core Functions

In the following, the focus of ESG orientation in operational practice is placed on risk management and the core functions of underwriting and claims management. The challenge for underwriting is that, in addition to the pure underwriting risk assessment, new fundamental decisions must now be made about the ESG quality of the business.

There are overlaps here, for example, when it comes to the issue of climate change and the effects of future extreme weather events that are difficult to predict on the exposure of risks.

Climate change will become a driver for increased damage costs, but will also lead to additional expenses in reconstruction when it comes to green or environmentally friendly build better programmes or more resilient building structures.

However, new dimensions are also emerging. Greenhouse gas emissions played only a subordinate or even no role in insurance terms, but as an ESG criterion they can be a decisive factor in underwriting the risk.

For example, the Partnership Carbon Accounting of Financials initiative (PCAF) has created a standard procedure for determining greenhouse gas emissions for the financial industry. This can be used for an individual risk as well as for an entire portfolio, so that, for example, new fossil fuel risks are placed on an exclusion list.

Scenarios that represent an environmental pollution risk have already been included in insurance terms. But, from an ESG perspective, this does not only apply to the exposed sectors; the negative impact on biodiversity, which has not yet been included in insurance terms, is also becoming highly significant.

In the past, the protection of human rights and the rights of indigenous communities only had a general political background. Now, for example, insuring a large infrastructure project in the rainforest from an ESG perspective could fail if the human rights situation is forecast to be negative. And, finally, governance issues such as corruption and unethical practices must also be addressed more intensively when underwriting risks.

Risk management is closely interwoven with underwriting. The captive can concentrate on analysing the risks of its parent company and work with it to develop risk metrics that are linked to its ESG risks.

Risk management also supports ESG compliance due to regulatory requirements and can simultaneously contribute to the development of measurement criteria for the assessment of sustainability risks.

This in turn enables the portfolio to be managed sensibly from the perspective of both climate risk and underwriting profitability. Risk management can also be interwoven with reputation management, which plays a special role in ESG issues, for example by identifying interfaces with NGOs and where problems for ESG compliance can be recognised at an early stage through direct communication channels.

Of course, the investment side is also important for a captive. Even if there are already funds under the Sustainable Finance Disclosure Regulation that contain classifications under ARt. 8 and 9 that provide for sustainability in a binding manner, this poses major challenges in practice, especially in terms of how, for example, financial alignment between the captive’s liabilities and assets is established through sustainable investment management.

4. Tackling the Data Challenge

To meet the requirements of ESG regulation and build a meaningful ESG risk management system, it is necessary to generate or collect the right data.

ESG data includes all indicators that provide information about the sustainability context of a company or its value chain. It is therefore important to identify the data required and to locate the data sources, whether within the company, at the client or in publicly available sources, and then to make them available in a way that can be used for business and audit purposes.

Historical data, of which insurers traditionally have a large stock, is suitable for this purpose, but current or future data is even more important. In addition to the question of quantity, there is also the question of data quality, which is an even greater challenge for many companies.

With the boom in generative AI, data quality in particular will need to be driven forward for the development of proprietary AI models. In particular, AI systems require high-quality data for machine learning and training in order to meet future regulatory requirements and to deliver correct and verifiable results.

The data horizon is also expanding to the extent that geospatial data is becoming increasingly relevant for ESG risk mapping, for example to assess the impact of climatic and man-made changes on the Earth and where preventive action can be taken.

Given the importance of IT systems in the insurance industry, it will be important to determine how data sources can be intelligently connected (data connectivity). This is all the more important given that many insurers still rely heavily on legacy systems that cannot be easily extended or replaced.

5. Building Interdisciplinary Teams

ESG covers many subject areas, requiring networked and holistic thinking regarding one’s own organisation and the impact of entrepreneurial activity. Therefore, it is important to include scientific principles and developments alongside economic and legal considerations. Working with interdisciplinary teams on the path to ESG compliance is highly recommended. The stakeholder approach can assist in identifying areas where special expertise is required.

If top management integrates the significance of ESG into its strategy and establishes this direction from the top down, it ultimately involves a new approach to corporate culture. Therefore, it is crucial to communicate the ESG strategy and, above all, how it is communicated, as this is a prerequisite for the company’s transformation towards sustainability to succeed.

6. Education and Awareness-Raising

Dealing with ESG factors is often viewed as a mere formality, involving ticking various boxes. However, successfully addressing ESG factors requires taking them seriously and integrating them into the company’s reality. This excludes ‘greenwashing’ certain activities, which can be dangerous in terms of liability, or ignoring ESG factors altogether.

The initial step is to raise awareness, which will result in increased transparency within the company. This necessitates training managers and employees through appropriate programmes.

Ultimately, employees are the crucial interface with customers and other stakeholders during implementation (e.g. via ESG KPIs). Ideally, this will generate the necessary commitment and integrate ESG factors into the process.

Young professionals, in particular, aim to contribute to the sustainability process and are increasingly recognising its importance in daily business operations. Training measures are most effective when employees are committed to implementing the ESG strategy and developing best practices.

7. Opportunity Mindset

It is important to communicate the opportunity side of the ESG issue within the company. Sustainability has become a competitive factor, and the issue of climate change alone requires a captive and its parent company to consider necessary adjustments to their business model.

The close relationship between captives and their parent companies’ business activities creates many synergies in sustainability. Captives can act as catalysts for overcoming sustainability challenges and risk management for the parent company. Insurance, in particular, can support the transformation to more sustainable business activities. The captive can support the development of ESG policies and action plans of the parent company.

New business opportunities may arise from the ESG strategy if it leads to value-enhancing data connectivity. The transition phase may also require new insurance solutions in many industries.

ESG regulation is often still “work in progress”. It is recommended to consider proactively the impact of regulations on your business, including potential new opportunities. Regulations can also lead to new business trends, which may require new insurance products or loss prevention strategies.


ESG is a long-term journey, not a short-term trip. Meeting the requirements of supervisory authorities may not be easy, but it is achievable with a focus on clear explanations and transparency.

Implementation may require investments, but these costs can be offset by good strategic positioning. While the task is challenging and complex, it can be accomplished with the right attitude and a structured approach.