The significance of environmental, social, and governance (ESG) issues within the insurance industry is more apparent than ever before. In the past, profitability and delivering value have been the primary concerns of company leadership, but ESG is rising fast in the hierarchy of corporate considerations.
A white paper released by Zurich North America and RIMS notes that today’s businesses are expected to strike a balance between profit and environmental impact. Companies now have to include “important and worthy non-financial considerations,” in their overall business strategy. According to the report, social and environmental proposals increased to 37% and 13% from 2020. Weighing the bottom line against increasing pressure to perform as a good corporate citizen is quickly becoming the norm.
What is ESG?
The umbrella of environmental, social, and governance (ESG) issues extends to cover sustainability, diversity, and industry or company-specific topics. Criteria including pollution, energy use, and waste management are evaluated to determine a company’s environmental stewardship. Stakeholder pressure to meet or exceed environmental standards is growing, with a reported 92% of S&P 500 companies releasing sustainability reports in 2020.
Social awareness and action are also assessed within a company’s internal and external relationships. Diversity, equity, and inclusion (DEI) principles are commonly measured to better understand an organization’s support for social issues.
ESG can also include how a company’s leadership is organized and involved within the firm structure. Everything from cybersecurity, to regulatory compliance, to executive pay are scrutinized.
“Certain hot-button topics within each of the ESG categories demand the attention of directors and officers and directors and officers (D&O) insurance providers because they represent perils that may increase the frequency or severity of existing D&O claim exposures — namely, securities class actions, shareholder derivative actions and regulatory matters,” said paper author Steven Boughal, chief underwriting officer, US financial lines at Zurich North America.
ESG-Related Events and Litigation
There are two ways in which ESG is involved in a D&O lawsuit; event-driven litigation following an ESG-related event, or disclosure-related litigation concerning an ESG topic.
Event-driven litigation involving a report in the media revealing adverse facts or allegations (true or not) about a company’s business practices or products are growing in prominence. This trend is leading to heavy litigation and settlement costs. Disclosure-related litigation transpires when a business fails to “regularly provide reliable, timely and accessible information about significant corporate matters.” When public companies disobey securities laws, or become entangled in a public ESG violation, it can result in costly legal action.
“All public companies are operating within an evolving ESG landscape,” said Boughal. “The litigation trend demonstrates that ESG decisions and disclosures will be challenged in court and that law firms representing shareholders will seek to compel substantial concessions, reforms and monetary commitments. These and future ESG lawsuits could potentially put the personal assets of a company’s directors and officers at risk. In addition to monetary compensation from the targeted corporations, recent lawsuits have sought to replace board members, recover their compensation and revise incentive plans.”
Leadership within public companies may be subject to securities class action (SCA) if investors are negatively impacted, or a shareholder derivative lawsuit if the company is harmed. ESG can be viewed as a framework for aligning the firm’s non-financial responsibilities in order to prevent these actions.
Zurich has previously noted that the growing prominence of ESG within the industry may accelerate the frequency of this type of litigation, evidenced by the number of lawsuits connected to diversity and inclusion practices, as well as cyber security.
“The litigation trend demonstrates that ESG decisions and disclosures will be challenged in court and that law firms representing shareholders will seek to compel substantial concessions, reforms and monetary commitments. These and future ESG lawsuits could potentially put the personal assets of a company’s directors and officers at risk. In addition to monetary compensation from the targeted corporations, recent lawsuits have sought to replace board members, recover their compensation and revise incentive plans.”
Large corporations such as Morgan Stanley are making their sustainability and ESG practices known publicly. A statement on their website pointed to the benefits of evaluating the firm’s ESG factors. “Material ESG issues are incorporated into our general management meetings, but we also believe that specific engagements allow us to look beyond an ESG data point and understand at a deeper level how a company’s ESG risks and opportunities are evolving, and impacting corporate strategy, current operations and long-term financial performance.”
ESG-related litigation is one way in which social issues are making their way into the forefront within organizational policies. With shareholder derivative actions concerning allegations of harassment resulting in a settlement in excess of $300 million in 2021, it is certainly one of the most costly effects. Litigation aside, ESG issues are gaining more focus as companies move forward in a socially-conscious environment, and ESG policy should be considered carefully by company leadership.
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