Captives, ESG Policies, and the Impact of the U.S. Election

This article originally was published on Captive.com and is reprinted here with permission.

Following the recent U.S. presidential elections, observers suggested the perceived backlash toward “woke” philosophies was likely to reverse the growing tide of corporate environmental, social and governance (ESG) policies. While there have since been high-profile moves among U.S. companies, such as Walmart’s decision to roll back its diversity, equity and inclusion (DEI) initiatives, a global view suggests ESG matters are far from likely to disappear.

That means despite the American voters’ apparent dissatisfaction with efforts to address environmental threats such as climate change, create greater social equity, and demand stricter behavioral standards for the leaders of both companies and governments, U.S. companies will continue to feel ESG-related pressures from the global marketplace.

No wonder companies of all sizes—but especially the middle-market companies whose continued viability depends largely upon their relationships with bigger customers—are seeking strategies for protecting themselves from the financial impacts of regulatory actions and litigation related to ESG requirements.

Currently, companies address some of their thorniest and potentially most damaging risks through specialized policies such as pollution, employment practices, and directors’ and officers’ liability coverage. However, ESG laws and policies create additional risks that fall outside the margin of these traditional insurance coverages. Whether it’s being prepared to defend ESG-related litigation or coping with a loss of revenue resulting from ESG requirements, company leaders are understandably eager to reduce their risks. Not surprisingly, risk managers are examining the use of captive insurance companies as a potential mitigation strategy.

The issues grow in importance along with a company’s exposure to global markets, either through its own business activities that may intersect with ESG rules elsewhere or its relationships with other companies.

It is expected that the ESG spotlight will intensify for publicly traded companies and the energy sector, especially regarding the impact of climate change. As larger-than-normal storms pummel many parts of the planet while drought renders other areas less habitable, certain industry segments will continue to be more prone to exposures in the ESG realm.

We’ve observed a trend of middle-market companies being pressured by the larger companies they supply and serve to prove they’re meeting ESG standards. A common element of corporate ESG policies is a requirement that vendors and partner businesses also align their business practices under similar policies. Whether the enforcement mechanism is a questionnaire or some kind of formal audit, it creates a risk of limiting or losing business.

Companies are being asked challenging questions that can be time-consuming and sometimes difficult or embarrassing to contemplate. Questions such as, “How have you measured your greenhouse gases, and what specific steps are you taking to reduce them? What are you doing to promote inclusion, and how has it worked? Which are your company’s top three environmental initiatives (please share documentation of progress toward each)?” Give an incorrect or incomplete answer to any of them, and the company may jeopardize loss of a key source of revenue.

Companies may even be expected to document compliance through their supply chains, so third- and fourth-tier suppliers’ business practices could be affected by the top company’s ESG expectations. When a key supplier of something challenging to source falls short of the standard -- whether that’s a company’s ESG policy or their customer’s –leadership may face costly, potentially litigious decisions.

The inherent flexibility of the captive insurance approach makes it a particularly effective option for mitigating ESG-related risks that aren’t easily addressed through the commercial insurance market. A captive can serve as an effective risk management tool and a buffer for exposures by building up reserves and risk-bearing capacity over time to hedge against the consequences of ESG-related events. When structured correctly, a captive can serve as a potentially self-funding incubator for identifying, mitigating and funding potential risks. It’s particularly effective as a way to insure projects that support ESG-related goals, offer customized ESG coverages not available in the traditional market or augment conventional coverage placements.

Of course, the key to a successfully run captive is establishing the proper foundation, which begins with the right guidance. A skilled captive consultant has expertise with what may be the biggest hesitation about including ESG-related exposures through a captive: the lack of historical loss data and accurately quantifying ESG-related risk, which can make determining funding a challenge. Techniques such as risk mapping, SWOT analysis, data analytics, surveys and site assessments all offer opportunities to quantify ESG-related risks and exposures. In addition, companies should rely upon a proven infrastructure for every step of the captive process, from actuarial work to negotiating with reinsurers, structuring policy language and delivering ongoing prevention services.

As ESG initiatives gain momentum globally, it’s clear they’re not going to disappear. Captives often serve as a scaffold for mitigating emerging risks like those associated with ESG. They offer the flexibility and speed required to adequately support the varied needs of companies seeking ESG insurance solutions, and it’s a safe assumption that risk managers will only find ways to utilize them more.

The above information does not constitute advice. Always contact your insurance broker or trusted advisor for insurance-related questions.