Vittorio Zaniboni, captive and insurance excellence leader, and Vanessa Müller, ESG lead of EY Luxembourg, on the unique opportunity captives have to leverage changing ESG regulations to their advantage

As the global community continues to face the pressing issues of climate change, resource depletion and social inequality, governments and organisations are increasingly looking to environmental, social and governance (ESG) factors to promote sustainability and responsible business practices.

In this context, the insurance industry is facing increasing pressure to comply with ESG regulations and accordingly develop ESG strategies.

Captives have found themselves at the crossroads of this evolving regulatory framework and have a unique opportunity to leverage ESG factors to their advantage, but this will require a new way of thinking about risk and opportunity.

ESG considerations for captives

ESG factors refer to a set of non-financial criteria used to evaluate a company’s ESG performance and can include carbon emissions, board diversity, labour practices and executive compensation, among others.

These criteria are becoming vital indicators of a company’s long-term sustainability and risk management.

From a regulatory perspective, the EU has embarked on major comprehensive endeavours to address the multifaceted challenges and risks associated with ESG.

Among those initiatives, the EU is actively engaged in developing regulations and frameworks that emphasise transparency and accountability, ensuring companies adopt practices that align with these criteria.

ESG investing is also becoming mainstream, with more investors incorporating ESG criteria in their decision-making.

ESG regulations typically encompass three key components. Captives must assess the impact of their operations across these three dimensions:

1. Environmental aspects that pertain to a company’s impact on the environment, including carbon emissions and resource management.
2. Social criteria that assess a company’s relationship with its employees, customers and the broader society.
3. Governance topics that evaluate a company’s internal policies, structures and ethical practices. ESG factors are particularly relevant to the insurance industry at large, due to its exposure to climate-related risks.

Natural disasters such as hurricanes, floods and wildfires can have devastating impacts on individuals and businesses. Insurers have a critical role to play in helping to mitigate these risks, captives included. Captives are typically created by larger organisations to self-insure against specific risks, and as such they are often viewed as a means to reduce costs and improve risk management. However, captives can also be used to support broader ESG goals, such as reducing carbon emissions, promoting social equity and enhancing governance practices. For example, captives could be used to fund renewable energy projects, support sustainable supply chains, or promote diversity and inclusion within the organisation.

The ESG challenges captives face

Insurers’ ESG scores improved in 2022, narrowing the gap with other industries, but overall results were mixed, with some prominent brands seeing declines. There are important hurdles to be overcome.

• Assessing and managing risks: ESG regulations entail a fundamental shift in how captive (re)insurance companies assess and manage risks. Traditionally, captives have focused on underwriting risks associated with their parent organisations. ESG regulations like Solvency II impose that insurers proactively identify and mitigate ESG-related risks. The Solvency II Directive requires market players to include their ESG risk assessment encompassing two climate risk scenario models in the Own Risk and Solvency Assessment (ORSA). This means insurance understandings would need to internally identify the areas covered via a materiality assessment and ensure the right evaluation models are integrated.
• Lack of standardisation: The lack of standardised ESG reporting hinders captives from benchmarking and improving performance. However, more ESG-reporting frameworks and tools are emerging to aid captives in assessing their ESG performance. For example, the Task Force on Climate-Related Financial Disclosures (TCFD) provides a framework for reporting on climate-related risks and opportunities, while the Global Reporting Initiative (GRI) provides guidance on broader ESG reporting. Newer regulations such as the Corporate Social Responsibility Directive (CSRD) and the Sustainable Finance Disclosure Regulation (SFDR) aim to further standardise sustainability reporting across the EU and ensure consistency among the disclosures on how ESG factors are considered in investments. These regulations are crucial for creating a common understanding of sustainable investments among market participants, promoting comparability and clarity.
• Balancing cost and returns: Investing in renewable energy projects may be seen as a positive ESG action, but it may also result in lower financial returns compared with traditional investments, especially in the short term. At the same time, captives may also need to invest in new systems and processes to track their ESG performance, which may require additional resources, such as staff training or software upgrades. Captives must balance these costs to avoid outweighing the benefits of ESG compliance.

Overall, ESG regulations such as IDD, Solvency II, CSRD and SFDR place increased scrutiny on captive insurance companies to integrate ESG factors into their operations, risk management, reporting and investment practices.

Yet compliance with these regulations is not only a legal requirement but can also be a strategic advantage as it demonstrates a commitment to sustainability, responsible business practices and risk mitigation in an increasingly ESG-focused global marketplace.

Despite their atypical business model, captive insurers should closely monitor evolving ESG regulations and adapt their practices accordingly to remain compliant and effective.

We have already seen some property and casualty captives active in the ESG space, with some of them even developing their own sustainability development goals, structured as enablers of the ones of their parent.

However, on the employee benefit side the situation is still quite static, with most employee benefit captives not yet fully engaged in ESG topics, without an agreed action plan, nor clearly defined priorities.

This may change due to growing regulatory pressure on captive decision-makers and their reporting requirements.

Practical steps for compliance

Establishing an ESG framework: The first step is to establish a comprehensive ESG framework, which should encompass policies and procedures that address ESG aspects relevant to the captive’s operations. Components should include:

1. Environmental risk assessment: Identify and assess environmental risks associated with insured assets. This includes evaluating exposure to climate-related events and pollution liability, and integrating the climate scenario modelling in the ORSA.
2. Social responsibility: Implement policies that ensure fair treatment of policyholders, employees and stakeholders. Address issues such as diversity and inclusion, customer privacy and community engagement.
3. Governance and ethics: Develop robust governance structures that promote ethical conduct within the captive entity. This may include forming committees and internal controls to ensure ESG compliance, as mandated by the Solvency II Directive, which requires integration of the prudent person principle and incorporating sustainability into the governance charter.

Data collection and reporting: Insurance captives should invest in systems that enable the collection of relevant ESG data from insured entities, as well as from their own operations.

This data should be reported in a transparent and standardised manner. Insurance captives can ensure accurate ESG data collection and reporting thanks to:

1. Data integration: Collaborate with parent organisations and insured entities to integrate ESG data collection into their operations. Automate data collection processes where possible.
2. Standardised reporting: Follow industry-recognised reporting frameworks such as the GRI or the Sustainability Accounting Standards Board (SASB) to ensure consistency and comparability of ESG reports.

Investment portfolio alignment: To comply with ESG regulations, captives must align their investment portfolios with ESG principles. This involves conducting due diligence on potential investments and divesting from companies that do not meet ESG standards. How can (re)insurance captives align their investment portfolios with ESG principles?

1. Engagement and proxy voting: Actively engage with companies in the investment portfolio to encourage ESG improvements. Participate in proxy voting to influence corporate governance.
2. ESG-screened investments: Consider investing in ESG-themed funds or companies that prioritise ESG factors. This is designed to meet ESG criteria and can help mitigate compliance risks. Long-term sustainability

The impact of ESG regulations on captives is profound and far-reaching. Captive (re) insurers must adapt to increased scrutiny, evolving risk assessment methodologies, and the need to align investment portfolios with ESG principles.

As the ESG landscape continues to evolve, insurance captives that proactively embrace these changes and integrate ESG principles into their operations will not only thrive in the new regulatory environment but also contribute to a more sustainable and responsible business ecosystem.