Financial services newsletter - Issue 2
Welcome to the second edition of our newsletter, where we cover some of the major developments across the financial services sector throughout the last quarter.
The Central Bank of Ireland (CBI) has outlined its expectations for Regulated Financial Service Providers (RFSPs) under its supervision. All RFSPs will be familiar with the increase in general governance requirements over the past ten to fifteen years. However, most are still at very primitive stages in developing appropriate Environmental and Social standards.
This article by Gary Stakem, Director of our actuarial practice, outlines ten steps on how insurance undertakings can leverage their governance and risk frameworks for success.
To empower the risk function, the Board must set an example, and make it clear that ESG is a top priority for the company:
EIOPA and the CBI have been clear on their expectations regarding climate scenario analysis. Before quantifying and mitigating these risks, insurers must better understand the threats (and opportunities).
Climate risk identification exercises need to be broad and deep. Some firms barely consider the impact of melting ice-caps and extreme weather events; much more rigour is needed to fully consider their second and third order impacts. There are many questions for insurers, such as:
Firms should first think broad and deep on the range of ESG implications. Only then can they begin to understand and assess risks in the context of their own operation.
Most Risk Appetite Statements (RAS) make limited reference to environmental and social issues. This overlooks the risk that climate change poses to the firm, but also the risk the firm poses to the climate. Reviewing the RAS through an ESG lens might unveil several shortcomings. Areas to consider include
Underwriting appetite - the RAS should define acceptable levels of underwriting concentration to climate related events. But insurers may also wish to look at limiting their capacity for covering risks that are harmful to the environment and increasing capacity for insuring greener activities.
Investment appetite - the company’s investment guidelines should be reviewed and updated in relation to ESG. If the firm invests in equities, it might increase its allocation to ‘green’ funds. Investment in corporates with poor human rights records might be prohibited.
Operational appetite - Insurers should be thinking of the carbon footprint of their offices, employees, remote workers, business travel arrangements, IT, and energy efficiency practices. They should also be cognisant of social issues like Diversity & Inclusion.
ESG tolerances should be reflected in governance policies and translated into specifics on:
While revamped Board Objectives, Risk Appetite Statements, and Governance Policies are a good start, firms should be wary of creating false promises and falling into the ‘greenwashing’ trap. The risk function can ensure that the words on paper translate to action on the ground.
A gap analysis of the current framework against ESG aspirations will go a long way. Internal controls should be consistent with the risk appetite, board objectives and governance policies.
Appropriate reporting and escalation of ESG control failures is of critical importance.
The ORSA is an established risk management tool that can add value in navigating ESG uncertainty. ESG analysis should go hand in hand with every aspect of the ORSA process and it should be core to the business planning feedback loop. Insurers should aim to have climate intrinsically baked into all stresses and scenarios in the same way the general economic landscape is currently.
The ORSA must be designed to answer the critical questions unique to each individual company. The ORSA results must enlighten Boards and senior decision-makers as they future-proof business strategies for the considerable change that is on the horizon.
Insurers would also be wise to Perform ‘ESG Gap Analyses’ across their entire product offering. There is a crucial question to be asked. In one/five/ten years’ time will the current product offering:
If the answer to any of the above is no, then action plans are required.
Most firms still don’t have a systematic or proactive approach for monitoring ESG developments. An effective Horizon Scanning process will bring key ESG developments to the attention of Board and Management and can hence influence organisational direction. Following the opinions of leading climate scientists and policy experts can help firms understand the implications of extreme weather, changing government policies, taxation shifts, and wider societal behaviour.
Engaging the third line of defence on targeted ESG audits will provide an additional layer of assurance to the Board and is a tangible indicator of the firm’s commitment to progressing its ESG agenda.
The firm can also bring ESG considerations into the scope of other internal audits. For example:
‘Greenwashing’ refers to the practice of exaggerating sustainability efforts or misleading customers to make them believe products and services are eco-friendlier than they really are.
Similarly, some firms may boast of their commitment toward Diversity & Inclusion matters by making statements on social media or by forming D&I committees. But are these committees actually empowered to bring about change?
Appoint a risk management champion who can steer the firm away from box-ticking risk management exercises and instead focus on measurable outcomes. The risk function can similarly act as the guardian against greenwashing. Firms should be held to account on tangible outcomes on areas like gender balance, energy efficiency and green investments.
Change is coming. Regulators expect it. Society expects it. And insurers are uniquely placed to significantly shape what comes next.
Most firms are willing to accept the challenge. But despite the good-will, there is a clear danger that organisations fail to transform their well-meaning words into actions. For that reason, the risk function is the ideal custodian to ensure ESG objective are met. An ESG-enhanced Risk Framework is the perfect tool to realise success. The Board must set the tone from the top and ensure the Risk Function is empowered and resourced to champion this cultural change.
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