Captive Review takes an in-depth look at how US captive owners should be approaching their ESG responsibilities.

Corporations have never been more under the microscope when it comes to properly managing their environmental, social, and internal governance (ESG) responsibilities.

The three are separate, but intertwine with each other, reflecting a corporation’s awareness of its impact externally on the world and people in it, and internally around how it treats its own staff.

It used to be that these were more ethical considerations, but in Europe especially these elements are all becoming more and more a part of what is expected as appropriate corporate governance.

Focussing on the US, there is a slight time lag in ESG expectations compared to Europe. Nevertheless, US captive owners should be recognising the ever-increasing importance of ESG, and preparing for the challenges and opportunities it can bring.

Challenges

First and foremost, it’s important to note that the US is a very litigious country, and every company should be forming a strategy to handle ESG risk as part of good risk management practice.

In isolation, each of the E, S and G may require their own dedicated resource, whether it be to ensure the business is not having an overly detrimental impact on the environment, is helping local communities and others it affects, or is fully abiding to the latest governance regulations.

Whatever strategy a parent organisation devises though, the captive should align with this.

“Captives have to be conscious of their parent’s principles and taking actions that adopt these principles,” says Anne-Marie Towle, global captive solutions leader at Hylant.

In practice, this could mean showing greater consciousness of where the captive invests its assets, and only working with trading partners that have similarly aligned ESG principles.

But Towle stresses a captive can go further than this to help their parent with ESG.

“With the captive as a separate legal entity, depending on how you structure it and the risk you’re retaining in the captive, it makes it a unique opportunity to do some innovative things,” she adds. “Whether it’s write a new coverage line, or use some of the funds in the captive to help support ESG initiatives, the captive can take it to the next level with your strategy.”

ESG coverage

Edward Koral, director in strategic risk consulting at WTW, agrees that there is much a captive can do to assist with managing a company’s ESG risk.

Far from just being an ethical concern, Koral recognises there is great downside risk attached to an ESG-related lawsuit or other adverse loss event.

The traditional insurance market is unable to adequately cover this risk, he says, and that’s where opportunity can arise for captives writing ESG policies tailored to their parent’s unique circumstances and principles.

“It often boils down to this: the company knows that it will need a large amount of discretionary spending money if a crisis event occurs,” Koral says. “This money may be used to reimburse employees for additional subsistence expenses in the wake of a natural catastrophe, to expedite changes to the supply chain, product and/or process re-design, emergency recovery support for the community, and other types of expenses not anticipated in the wording of a conventional insurance policy.”

In this way, a captive can play a leading role in determining ESG strategy and response. The challenge for risk managers and captive owners is being able to quantify a corporation’s overall ESG risk exposure.

Questions include agreeing what would cause a loss, and how one would adjust or even estimate the loss.

“The answers are not straightforward since the definition of corporate social responsibility is a moving target,” Koral adds. “A company cannot easily predict what actions it will need to take, or what those actions will cost, in response to an undefined crisis event affecting that company’s relationship with employees, the community, the physical environment, and other important constituents such as shareholders, lenders/investors, and more than ever, public opinion and the media.”

To overcome this problem, Koral suggests introducing parametric ESG policies to the captive, a solution he fully explains in another article here.

Regulation

Part of the issue, and why Koral suggests a parametric response, is because perceptions around ESG requirements are ever-changing, and becoming more onerous, especially in the US.

Some aspects of ESG are so new, especially around climate change and environmental responsibilities, that it is difficult to get common ground on exactly how much is expected of a captive.

Regulators are those best positioned to set the standards for ESG requirements, and already set the rules around governance.

However, in the competitive world of captive domiciles, it’s understandable that none wants to be seen as setting overly arduous and restrictive ESG rules.

“If some domiciles start to adopt new ESG rules and really enforce it, people might view it as a bit onerous, but it depends,” says Towle. “There could be areas where the domicile regulator is just asking questions and raising awareness of ESG practices, without having fines or penalties and going to that type of extreme.”

Joe McDonald, director of captives for South Carolina, agrees with such a less onerous approach.

“We need to be careful not to overstep our positions as regulators,” McDonald says. “We need to set standards in statute and apply those standards appropriately.”

Nevertheless, captive domicile regulators around the world are having discussions around how to best encourage captives and their parents to step up their ESG focus.

Because, while solvency is the main factor regulators assess when setting standards, McDonald recognises that in the coming years, as ESG matters grow in importance, a clear ESG strategy will most likely complement a good solvency rating.

While there are no plans in place to introduce new ESG-related regulations, he advises that to have the best chance of long-term success, captive owners and their parents should be giving strong consideration to ESG matters.

“We can already see there are really positive promoters of ESG initiatives in the market, and I think you’ll see a lot of those companies begin to separate themselves from other companies,” McDonald says.

If such a link between ESG strategy and financial performance does emerge, McDonald says there may be good reason for domicile regulators to consider putting new ESG-related rules in place.

For now, though, his view is that a captive that takes ESG seriously shows itself to have forward-thinking and responsible leadership, and this bodes well for future responsible capital management.

Still, this matter is only going to rise up the agenda of captive regulators in coming years.

The more pressure regulators apply among not just captive owners, but also captive managers and other service providers, the more isolated those that choose to ignore these matters will become.

That’s why implementing an ESG strategy now is the best way for captive owners to protect themselves.

“I’ve always said it’s best to be proactive, not reactive,” Towle adds. “We’ve always promoted captives as being at the cutting edge of insurance, so it’s important they pay attention to this risk because it’s not going away.”