Identifying and mitigating Greenwashing Risk: Considerations for Insurance Firms

• Greenwashing continues to be a key concern for regulators, governments and industry.
• While regulators have primarily focussed on the actions of asset managers, insurance firms are also exposed to greenwashing risk.
• Greenwashing risk can arise inadvertently. Without appropriate governance and oversight, insurance firms are particularly susceptible to the actions of third-parties in the value chain.

The past 12 months have seen governments, industry and regulators outline measures to further promote the financial sector’s role in combating climate change and deliver on Paris-aligned transition plans.¹ However, greenwashing has become a key and growing concern for regulators as more firms are making Net Zero commitments, announcing targets, and designing ‘green friendly’ products to help meet them. Regulators have made it clear that greenwashing is now a ‘material risk’ and supervisory action will be taken against firms found to be misleading customers, investors and other key stakeholders over the sustainability of their product offerings or transition plans.

Greenwashing: risk drivers for insurance firms

As we have outlined in our previous blog, greenwashing risks emerge in a variety of risk categories, such as strategic, legal, compliance, and reputational risks. The insurance industry must identify, monitor, and manage these risks and their potential drivers carefully.

Greenwashing risks for insurers are heighted as a result of:

• Increased ESG product demand: With a growing demand for ESG products from customers, firms are under pressure to communicate positively about their product offerings. Life insurers may note a growing demand for ‘green’ pensions and investments in ESG-linked funds, and there are an increasing number of general (Re)insurance firms looking to roll out specific ESG products or advisory services such as carbon credit solutions or carbon offset insurance. Other examples include insurers offering to invest a proportion of their customers’ premium in socially responsible or environmentally friendly investments, or insurers setting up new subsidiaries as ‘sustainable’ or environmentally friendly, in an early bid to corner a fast-growing market.

• Lack of common definition and credentials: The absence of a common definition of what constitutes an “ESG product”, and a lack of verification of product claims provides the opportunity for concerns to arise over the credibility of ESG product credentials. Insurers should take care in circumstances where existing products are rebranded as ‘green’ or ‘climate friendly’ without robust process and review, in accordance with their risk management framework. Insurers should look to upcoming regulatory developments and a the developments of ‘green’ taxonomies, such as the work undertaken by the EU commission to operationalise the EU’s taxonomy regulation. However, attempts by different jurisdictions to develop their own green taxonomies have proven difficult, particularly in the EU. The upcoming UK government consultation on its on UK Green Taxonomy should provide UK-based insurers with clearer guidance on UK regulatory thinking.

• Availability of ESG screening data: There is a lack of consistency over the completeness and accuracy of ESG data quality and impact this has on disclosures. Product providers have significant challenges in gathering the data required to ensure that sustainability criteria are met. For insurers, this is particularly important for policies underwritten where there is less consensus over what represents an acceptable ESG profile or what data points are available or required to collect.

• Availability of data to innovate: A lack of data can also impede the innovation of products that have ESG or climate-friendly goals. A lack of available historical data, such as claims performance for new renewable energy technologies creates significant challenges for firms to underwrite and price new products. For available historical data, the past is not necessarily a reliable indicator of the future in a changing climate. A consequence of this could be the creation of products that underperform against their stated ESG goals. Similarly, ESG metrics, such as scope 3 GHG emissions, that depend on inconsistent or inaccurate data will also hinder insurers’ ability to underwrite and price products.

• Reliance on third parties: There is uncertainty around the extent of third-party actions raising or inadequately mitigating the risk of greenwashing or undermining green claims made by firms. On the investment side, insurers are particularly exposed to the actions of third-party asset managers, which are commonly used by medium to smaller sized insurers. For underwriting, the complex nature of insurance value chains also means that insurers in the corporate and speciality space may have little to no direct contact with the end clients they insure and are reliant on the actions and representations from intermediaries.

Greenwashing: impact on insurers

Insurers are both able to be the source of greenwashing, via the disclosures and representations they make to the market, and exposed to greenwashing from inadequately mitigating risks arising from reliance on third parties such asset managers. This can manifest itself in three key ways:

1. Ability to understand, select and price risks in underwriting

An increasing number of insurers have outlined plans to exclude or restrict underwriting activities for carbon intensive industries, such as thermal coal mines, oil sands, or Arctic energy exploration activities. Many insurers are also starting to make ‘Net Zero’ underwriting commitments to decarbonise their portfolios. These can be based on identifying insureds that make a minimum percentage of their revenue from carbon intensive activities. However, without agreed definitions for these activities or globally recognised frameworks to support consistent monitoring and reporting, this increases the risk to insurers of inadvertently greenwashing. Currently, many insurers do not have the data or granular understanding of these risks in order appropriately mitigate greenwashing risks. Further, excluding whole regions, industries, or classes of business also risks excluding firms with credible Net Zero transition plans who may be critical to the decarbonisation of the global economy. Many insurers recognise these challenges and are seeking to adopt more flexible ‘enablement’ approaches with clients that favour engagement and guidance over exclusion. However, insurers must demonstrate robustly how these approaches align to their own climate strategies and Net Zero commitments and engagement must not be used as an excuse to maintain current business relationships with high-carbon industries.

2. Understanding exposures in investments

The FCA states that the ‘sustainable’ label is applied to a very wide range of products, some of which do not have obvious sustainability characteristics’.² The UK regulator wants to prevent situations where greenwashing risks are not identified properly in the sales process, which would lead to investors and customers being misled or mis-sold products that do not meet their needs. We are seeing insurance companies enhance their product governance, distribution and delegated authority oversight frameworks to include these considerations.

Insurers are also exposed to actions of their asset managers and the asset management industry in this space as are the clients who may be mis-sold green products. With over £1.8 trillion of assets under management, equivalent to 25% of the UK’s total net worth, developments and greenwashing risks can have significant implications for the UK economy if inadequately mitigated.³ This is particularly the case as insurers increasingly make Net Zero commitments to decarbonise their investment portfolios. This reinforces the importance of insurers having a framework to test the robustness of, and hence reliance on, ESG disclosures made by their asset managers.

3. New Products / Misleading Clients

The FCA’s Dear AFM Chair letter, outlined how existing guiding principles developed by the FCA can be considered by firms in the design, delivery and disclosure of sustainable investment funds. Of these principles, PRIN 2.1, Principle 7 of the FCA’s principles of business should be considered by insurers to clarify if and how their product’s environmental and social objectives are pursed and to do so in a way that is “fair, clear and not misleading.”⁴ As the market looks to issue new sustainable products, the risk of inadvertently greenwashing is heighted. Life insurers are particularly exposed if they make claims that pensions funds a ‘green’ or ‘sustainable’ and while still nascent, there is growing evidence of sustainable products from General Insurers, particularly in personal lines space with sustainable claims policies.

Greenwashing: Considerations for identifying and managing Risks

There are a number of actions firms can take to identify and mitigate the potential for greenwashing or a perception of greenwashing occurring:

• Understand their obligations in a fast-changing regulatory environment
• Develop a comprehensive approach for integrating greenwashing risk identification and management across their entire operations which considers existing governance, product development, sales and pricing processes.
• Develop a robust ESG data strategy and target operating model to improve the completeness and accuracy of ESG risk data, taxonomy-alignment and disclosures.

The insurance industry will play a vital role in facilitating the transition, through using its unique risk identification and management skills to inform other sectors of the economy and financial services of the sustainability risks they face, and having the opportunity to deliver positive social and environmental impact through its investments and underwriting practices. By taking the necessary actions to ensure it mitigates greenwashing risks, the insurance industry can gain comfort that they are contributing positively to a Net Zero future.

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References

¹ See our stocktake of regulatory developments leading up to and during COP26.

² https://www.fca.org.uk/publications/corporate-documents/fca-climate-change-adaptation-report

³ https://www.abi.org.uk/data-and-resources/tools-and-resources/regulation/insurers-as-investors/

⁴ https://www.handbook.fca.org.uk/handbook/PRIN/2/1.html