ESG Principles

Risks and terminology for actuaries to know

Elizabeth Walsh

Photo: iStock.com/Petmal

Recently there has been an increased focus on structuring and institutionalizing environmental, social and governance (ESG) principles for insurers. Consequently, actuaries are under pressure to stay informed about ESG investment topics and technology, embed ESG issues relevant to the insurance business in their decision-making and effectively recognize the means through which the state of an insurer’s ESG practices translates into associated financial performance.

ESG is critical to the well-being and success of an insurer. Those that adequately respond to ESG broaden their partnership opportunities across the value chain as their ESG policies are assessed for due diligence. Regulators require climate-related risks to be embedded within risk management frameworks, along with the U.S. Securities and Exchange Commission (SEC) rule-making and enforcement expected around human capital and climate-related disclosures and the new New York Department of Financial Services (NYDFS) climate-related supervisory expectations of regulated insurers.

There is a growing demand for ESG-compliant insurance products, investments and related disclosures that goes beyond investment-linked products. There are inherent risks related to pricing impact due to material exposure through underwriting, issues of data availability and quality, higher fees for ESG-friendly investments by asset managers and tail volatility due to governmental, legislative and regulatory developments.

To help address the ESG investment knowledge gap and better manage risk, Figure 1 provides a high-level “cheat sheet” on commonly used ESG investment terminology for actuaries.

Figure 1: ESG Terminology for Actuaries

Terminology Meaning for Actuaries
Environmental, social and governance (ESG)
  • A system of nonfinancial factors used to measure the sustainability of a company or investment
  • Do not confuse this term with “economic scenario generator,” which is used for regulatory reserve and capital calculations
  • Relevant environment pillar for actuaries: climate change vulnerability
  • Relevant social pillars for actuaries: human capital development, privacy and data security, responsible investment and insuring health and demographic risk and access to finance
  • Relevant governance pillars for actuaries: corporate governance including board, pay, ownership and accounting; and corporate behavior including business ethics and tax transparency
Principles for responsible investment (PRI)
  • Defines responsible investment as a strategy and practice to incorporate ESG factors into investment decisions and active ownership
  • Appropriate when consideration of ESG issues is motivated by financial objectives
Sustainable investment
  • Appropriate when investment is motivated by financial objectives, having regard for long-term sustainability
Impact investment
  • Appropriate when investment is motivated by both financial and social or environmental objectives
  • Differs from sustainable investment in that investment is intended to have demonstrably positive social or environmental outcomes, not just avoid negative outcomes
Ethical investment
  • Appropriate when ethical criteria are applied to investment decisions in ways that override financial considerations—for example, excluding tobacco manufacturers from an investment portfolio on the grounds that their business is morally wrong
  • Choice of ethical criteria reflects personal values
Long-term investment
  • When investments are held for several years and investors are not particularly concerned about lower returns or higher volatility in the short term
Patient capital
  • Related to long-term investment
  • Refers to the money that is invested rather than the investment approach itself

Actuaries can apply their nontraditional data expertise, cross-functional skill set and model development background to contribute to ESG and sustainability efforts. We can innovate and advise within and outside of the insurance industry, and in turn, do our part in creating a more sustainable and resilient society.

Elizabeth Walsh, FSA, MAAA, is a consulting life actuary in New York and a contributing editor for The Actuary.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

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