ESG and insurance

Insured Success

Mark Pring, Catherine Lewis, and Tom Morgan break down the three pillars of ESG (Environmental, Social, and Governance), and discuss current risks that policyholders are facing and how they should go about mitigating certain risks.

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Transcript:

Intro: Hello and welcome to Insured Success, a podcast brought to you by Reed Smith's insurance recovery lawyers from around the globe. In this podcast series, we explore trends issues and topics of interest affecting commercial policyholders. If you have any questions about the topics discussed in this podcast, please contact our speakers at [e-mail]. We'll be happy to assist.

Mark: Welcome back, everyone to our podcast series, Insured Success. My name is Mark Pring. I'm delighted to be joined by my insurance colleagues, Catherine Lewis and Tom Morgan to talk about some topical issues relating to ESG risks and how policyholders can try and mitigate such risks. I know you've both written quite a bit on ESG risks on our Policyholder Perspectives blog. Tom, starting with you and focusing first on the E in ESG what are some of the key risks facing Corporates at the moment?

Tom: Yeah, sure. So climate related litigation is the obvious one. So climate related disputes in the UK traditionally have focused on, you know, challenges to government decision making and policy through the judicial review mechanism. But I do think we're now seeing a change of approach focusing instead on corporate actors as, as the strategic target. I think this is in part because of increased transparency and disclosure requirements placed on corporate entities which produces more actual information and gives claimants greater scope to target claims based on, you know, embedded international standards and settled climate knowledge.

Mark: Ok. And what types of claims are we talking about here?

Tom: Yeah, it's a pretty wide array really. Challenges are coming from investors, consumers, activists, regulators and also litigation funders are increasingly looking to back some of these claims. Strategic climate change claims like the recent client Earth action, for example, targeting off directive notably failed to get off the ground, but it's unlikely to be the end of these types of claims in the UK. This exposure is arguably higher since the UK became the first G20 country to put into practice the goals of the task force on climate-related financial disclosures by making it mandatory for the UK's largest companies and financial institutions to report on their climate change risks. Activist claimants in the UK therefore often supported by institutional investors potentially have greater ability than in other jurisdictions to hold corporates to account. They can closely scrutinize disclosed metrics and net zero transition plans with reference to the impacts on agreed international standards.

Mark: Thanks Tom. So this, this seems to be a sort of information paradox, if I can call it that. On the one hand, you have inadequate disclosure of information which may give rise to corporate liability. Yet, publication of the same data may provide a foot in the door for strategic litigation against those same corporates.

Tom: Yes, exactly. So this risk is obviously at its highest for high emitting corporates. However, prospective claimants could target any sector, particularly those directly or indirectly financing carbon intensive companies, but also a wider array of industries including for example, financial services, retail, agriculture, and transport. Many of these you know, companies in these industries will also have set 2030 reduction targets and obviously 2050 beyond that. So we could start to see the claims rack up uh in the near future.

Mark: Understood. So what about the more traditional types of claim those seeking loss and damage?

Tom: Yeah, there haven't really been many breakthroughs in the English Court yet. However, outside of the UK, there has been a growing trend of claims seeking compensatory damages, the indirect impacts of climate change. One claim I'm following particularly closely has been brought by a Peruvian farmer against RWE in Germany. He said for the cost of constructing flood protection measures in his village in Peru which he claims that emissions released by RWE in Germany contributed to. The case is ongoing. But importantly, a uh a German court of appeal has already found that in principle, a polluter can be liable for the impact of climate change.

Catherine: And we should also note that loss and damage were also again a headline issue at cop 28 with the agreement to support developing countries suffering the impacts of climate change. And I think the acknowledgement that high emitters have a responsibility to compensate the damage caused to developing countries that are disproportionately impacted by climate change seems to align with this type of claim.

Mark: I completely agree. And um it's fair to say the English courts have always been a popular forum for international litigants assuming claimants can establish jurisdiction in the first instance. If the actions are successfully elsewhere, they may set a powerful incentive for more claims in the English courts.

Tom: Yes, completely agree. This may also be bolstered by the rapidly outstanding field of attribution science which by seeking to accurately measure the causative connection between climate change and individual environmental events will likely provide a further evidentiary basis for claimants against corporate actors. Furthermore, English courses are already dealing with complex group actions for loss and damage in relation to other environmental issues. And the overall trend is favorable towards complex actions involving questions of science attribution and quantum. So, you know, for example, last year, the court of appeal decided that the group action against BHP in relation to the Mariana dam collapse should continue despite its complexity and multijurisdictional nature. Surviving BHP's attempted strikeouts. You also have the vast Dieselgate claims going through the courts at the moment.

Mark: Yeah, I think we're we're all in agreement that class actions are likely to be a real growth area uh in terms of the types of claims that, that we're seeing in the near future around ESG. Insurers uh, will have to stay on top of, uh, what is a changing and, and growing risk profile for them. So, just shifting across and focusing now on the topical area of greenwashing, this is another risk area. If you like that we're starting to hear a lot about again with that wider access to company information and related disclosure requirements, as well as increased consumer pressure, companies appear to be at more risk than ever of greenwashing claims. Tom, did you have any thoughts?

Tom: Yeah, definitely. So, actions related to greenwashing in the UK typically require the claim to bring a claim for misrepresentation which requires reliance on misleading statements which can often be difficult to prove. However, increasing sustainability disclosure obligations for public companies as we've just discussed, offer an alternative route as claims for misstatement or publication of misleading disclosures can be brought against companies by investors.

Catherine: Absolutely right. I think it's also important to add here that whilst there have not been any notable greenwashing legal cases in the UK, regulators are wrapping up their focus on misleading and unsubstantiated claims made by companies about their environmental impact. So most recently, the CMA, the Competition and Markets Authority, has started an investigation into whether Unilever has overstated the sustainability of some of its products. And there will undoubtedly be more regulatory scrutiny of similar marketing endeavors by other companies who make climate related statements and advertisements. I'm sure you'll have seen adverts for certain international airlines have recently been banned for making misleading statements to consumers about those airlines environmental impact.

Mark: Absolutely, Catherine, we've all seen it. Just pausing here for a moment, we've been talking particularly about environmental risks and of course, this is an insurance podcast. So just for the moment, let's let's focus on uh the application of all of this to, to the insurance context. And obviously one means of mitigating the risk of direct corporate claims is through tailored insurance programs. But the sting in the tail is that the same growth in the risk of exposure to climate litigation has also resulted in increased demands for insurance coverage for such risks, then limited available capacity in terms of uh insurer appetite and also greater scrutiny from those insurers of placement and renewal of the risks. The result of all this being the further risk if you like of policy coverage disputes as and when uh a claim may arise. Catherine, do you, do you have any thoughts on this?

Catherine: Yeah. Um I completely agree with that and I think uh what we will see is that insurers will increasingly expect their insured to accurately disclose the risks that they face from climate change. And this seems to be particularly the case in light of climate litigation trends, which are expected to focus on the liability of Corporates to assess manage and disclose their vulnerability to a changing environment, changing economy and and changing customer expectations. And that is in addition to the traditional risk exposures.

Mark: I agree. And I think my personal view is that insurers are likely to focus on some key points. So first of all, the increased likelihood of insured claiming on liability policies as a consequence of claims relating to climate change. Secondly, management and governance claims in respect of climate change, where directors and officers could be held personally liable uh for failing to consider climate impacts in their decision making. And then finally, failure to properly measure and report company exposures to climate related risks as required by the TCFD that Tom mentioned earlier. For directors and officers, the new reporting obligations here in the UK and elsewhere could lead to personal accountability. So just moving on, we've talked about E, are we losing sight of uh the S and the G? Catherine, any thoughts on that?

Catherine: Absolutely right. So, whilst climate change and environmental issues are quite rightly very high on the agenda of all corporations as governments and individuals um take steps to mitigate the impact of climate change. I think it's really important that corporations don't lose sight of their obligations and consequent risks under what we call the social and governance elements of ESG.

Mark: Again, I completely agree. This is, this is obviously a rapidly developing area and insurers are gonna be under pressure to keep up with the range of judicial decisions and regulatory intervention in this context as well as the potential implications for coverage under their liability policies that they're writing. I think above all, we expect to see insurers probe policy holders at renewal in order to understand uh better uh their ESG related risks and liability policies, particularly directors. And officers liability policies even now we're seeing increased claims.

Catherine: I completely agree with that Mark. So shall we move on then to the, the S, social aspects? And this involves a corporation's interaction with its employees, customers and its stakeholders. And I think diversity and inclusion will continue to be a huge focus for various key stakeholders. In particular investors, customers and employees, businesses are ever increasingly being held to account by stakeholders to do more than simply pay lip service to DEI policies or risk litigation, regulatory action and reputational damage. I think in the same way that greenwashing is considered a litigation and regulatory risk companies may also increasingly find themselves at risk of social washing claims if they mislead about the positive social impact they claim to have. And so, for example, I think multinational sports brands have more recently come under fire in the media for making public statements to combat racism whilst facing reports of allegations of racial discrimination by their own employees. And I think it's only there for a matter of time before we start seeing the first of these so called social washing uh legal actions to to follow.

Tom: Yeah, sure if I can jump in there as well, I think another key theme in merging in the social limit of ESG is health and safety and working conditions. One of the key pillars of ESG related policies is transparency and that's not just the transparency of the business itself but also how it operates on the international stage. A number of claims have reached the English Courts in recent years. The UK Supreme Court, for example, found that a parent company could over duty uh get in respect of operations carried out uh by an overseas subsidiary, particularly in I'm thinking of the Vedanta case. And as I mentioned earlier, the Mariana Dam case relates to BHP subsidiary company which is also being sued in Brazil.

Catherine: These are really interesting developments, Tom and I think these cases demonstrate that the English courts at least are potentially willing to acknowledge the responsibility of an apparent company towards its workers in countries where its subsidiaries operate.

Mark: Yeah, and while it's easier said than done risk in this area can be mitigated by having clear policies in place as well as fostering a culture of transparency in order to allow for incidents such as those to be investigated and and managed appropriately. Policyholders in that context should also seek be able to seek, I should say to demonstrate to insurers that they have appropriate oversight of uh not just their domestic operations but but overseas operations as well. So conscious of time. Should we then focus on the G and ESG, governance, and Catherine, do you have any initial thoughts?

Catherine: Yeah, thanks, Mark. So this aspect encompasses a business's ethical and legal management, how a company governs itself. And this is a very broad topic and it's developing in many, many areas. And currently, um I think there's a clear focus on transparency and this ties into points we've been discussing already that customers and shareholders are rightly holding businesses to account. So in terms of a business’s leadership, in mid-2022 the FCA issued policy statement 22/3, which introduced changes to the UK listing rules and imposed a new comply or explain obligation to seek to improve the diversity of the board and executive management of listed companies. Great news. A key concern for businesses as a result of these comply or explain requirements will be the extent to which claims under section 98 of this, the Financial Services and Markets Act follow alleging for example, misleading disclosures in things like the annual reports produced. So a lot to think about and I don't think it's likely to be the end of de and I policies implemented by UK regulators. I'm sure we can expect both the FCA and the PRA to continue to focus on the diversity of businesses listed in the UK. And in addition to the makeup of a company's leadership, we are seeing increased scrutiny of supply change. It's no longer sufficient to ignore or profit from bad practices or illegal activity happening elsewhere around the globe. Um What do you think, Tom?

Tom: Yeah, I mean, I'd say that the key elements of this risk have actually existed for some time. So the modern slavery act requires companies to produce a slavery and human trafficking statement for each financial year. Assessing the modern slavery risk and supply chains in the business And looking at the bribery act, which also applies where an offensive an offense is committed overseas by a person connected with the UK. We have the EU's new deforestation regulation which came into force in June 2023 which requires companies to conduct extensive due diligence on their supply chains when dealing with certain products. I'm thinking, you know, cattle, cocoa, coffee, palm oil, soya, wood. So implementing robust policies, regular training and clear reporting lines will enable the risk to be monitored in incidents when they do arise to be managed appropriately.

Mark: That's all very practical and just thinking sweeping all of this up in terms of mitigating ESG associated risks. It's gonna appear daunting for many insured, but it is, I think possible to navigate the positive changes brought about by an increased ESG focus through implementing in particular as we've discussed already robust policies and procedures. Uh Insurers expect to be informed about a company's ESG awareness and related programs as well as the implementation of those programs and policies and indeed their monitoring. In particular I and others have noted that D&O underwriters have been eager to understand what disclosures and commitments insured have made to the public and whether there are any underlying claims relating to such disclosures. For example, whether the directors have made claims about the diversity of the company's board of directors or the company's climate change statistics. Catherine any, any sweep up thoughts here.

Catherine: Yeah, I have a few. And we've all been thinking about the steps that policyholder can be taking in this environment and I'll just run through a few that, that we've been talking about. So one of the things that um a policy holder can be doing is to implement clear sustainability and ESG frameworks that cut across all business stakeholders. So in this regard, they can also produce um environmental and social impact assessment and just as importantly as producing the original assessment, have processes in place to monitor and update any impact assessments so the risks remain relevant. A policyholder should also be starting to really ensure that controls and processes are in place internally to ensure early identification of specific threats facing the business. So specifically, for example, ensuring that the money laundering reporting officer, MLRO, and other reporting and compliance functions are connected to the areas of the business where risks might arise to ensure that there's prompt notification to the insurance and legal teams. In addition, it's helpful for all parts of the business to engage proactively with legal teams to stay abreast of rapidly changing legislative and regulatory frameworks. And we've discussed this in some detail already and it's no longer acceptable or even possible to turn a blind eye to what's happening overseas. It's also helpful for policyholders to start thinking about having dedicated ESG managers whose role it is to collect relevant data and monitor risk. Finally, from me, an organization should start putting into place clear plans for implementing targets, whether these are climate based targets or DE&I based. And these plans should have concrete steps that can be demonstrated to insurers and regulators.

Tom: Great, thanks Catherine. And just one more point from me, policyholders should really engage with insurers and or their brokers early ahead of a policy renewal. They should when doing so expect questions in proposal forms and in discussions with the insurers about what steps are actually being taken to mitigate the risks associated with ESG.

Mark: Great points at the end there from both of you. Thank you and thank you everyone for listening to Insured success. We absolutely look forward to joining you again for another episode. Bye bye.

Outro: Insured Success is a Reed Smith production. Our producer is Ali McCardell. This podcast is available on Spotify, Apple Podcasts, Google Podcasts, PodBean, and reedsmith.com. To learn more about Reed Smith's Insurance Recovery Group, please contact [e-mail].

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