Delaware Department of Insurance
ESG challenges and how captives can meet them
Stephen Taylor of the Delaware Bureau of Captive & Financial Insurance Products provides an overview of ESG issues facing businesses and imagines how the captive insurance industry might help businesses manage their ESG issues and risks.
“Captive managers argue that the existence of a captive itself shows good governance by its owner.”
Stephen Taylor
Delaware DOI
Let’s imagine that you have settled into your new position with the Delaware Department of Insurance Captive Program. You have been working to improve the captive insurance programme and are looking at opportunities for where captive insurance can assist business. You stated that environmental, social, and corporate governance (ESG) issues is one area you are exploring for new captives and the expansion of existing captive programmes. So, what is ESG?
ESG is a framework that assists stakeholders, including investors, regulators, legislators, employees, customers, suppliers, and community members, when they’re assessing how a business organisation is managing risks and opportunities related to environmental, social, and governance factors. Those factors form the basis for an organisation to develop initiatives to address its ESG strategy.
Environmental factors refer to an organisation’s environmental impacts and risk management practices. These include direct and indirect greenhouse gas emissions, energy efficiencies, management’s stewardship over natural resources, and the organisation’s overall resilience against climate risks such as flooding, drought, and wildfires.
The social pillar refers to an organisation’s relationships with some of its stakeholders. Examples of social factors on which an organisation may be evaluated include human resources issues such as fair wages and benefits; diversity, equity, and inclusion; and employee engagement. It also may include the organisation’s impact on the communities in which it operates, or its supply chain partners.
Other social issues for an organisation may include privacy and data protection, health and safety, and other social justice issues.
Governance refers to how the organisation is led and managed. These issues may include how the leadership’s incentives are aligned with stakeholder expectations; how shareholder rights are viewed and upheld; and what types of internal controls exist to promote leadership transparency and accountability.
Why is ESG a big deal?
ESG initiatives have become a strategic imperative for many organisations over the past years as a reaction to some of the social and economic challenges that arose during the COVID-19 pandemic. This is due in part to the increased focus and pressure from some of those shareholders I referenced earlier to address the social and economic issues that were amplified during the pandemic, as well as ongoing and growing environmental concerns.
These ESG initiatives by the business community can provide new opportunities for captives in Delaware, in terms of new formations or expanded captive programmes by businesses seeking to better manage their ESG issues and risks.
How will captive insurance help?
Some captive managers believe, and I agree with them, that a captive is ideally positioned to assist organisations in all three ESG areas.
With respect to the environmental factor, a captive can be utilised to fill any gaps that are created by some commercial carriers. These gaps may occur as some insurers reduce their ability to underwrite carbon-intensive risk as they look to reduce their carbon-intensive investments. It has been reported that captives owned by parents in affected industries are being used to address coverage gaps and exclusions, climate-related perils, third party coverages, and renewables.
I agree with managers of captives that this trend is expected to grow over time as the economy transitions to a low-carbon future. Indeed, Delaware has seen an uptick in business interruption and supply chain coverages.
I understand that a captive can enable organisations to reduce the total cost of risk and enhance sustainability as a long-term strategy that allows them to preserve assets and improve resilience.
In terms of addressing an organisation’s social initiatives, captives can support a company’s diversity, equity, and inclusion strategy. One example cited by a captive manager is to provide employee benefits coverage that harmonises coverage across geographies, or to cover exclusions in a commercial policy such as one that may exclude neonatal care.
With respect to the governance factor, captive managers argue that the existence of a captive itself shows good governance by its owner. Not only does it provide a formalised loss-funding vehicle licensed by a regulator, it protects the owner against risk. Additionally, captives play important roles in governing, managing, and financing the owner’s risk.
What about compliance?
As reporting on an organisation’s ESG initiatives becomes more prevalent and more regulated, there is likely to be increased compliance and shareholder risks for organisations and their boards.
Additionally, liability risks related to environmental factors could emerge from things such as growing regulatory requirements to disclose climate exposures; potential liabilities around “greenwashing”; and litigation against some businesses alleging a direct impact on climate change. Also, a company’s failure to adhere to ESG best practices or a poor assessment of its ESG programme could negatively impact the company.
For example, S&P reported in its June 2023 “ESG In Credit Ratings Newsletter” that its ESG-related rating actions increased to 25 in May 2023, nearly double the previous month's tally, and negative rating actions outweighed positive actions.
A captive may be helpful in addressing these risks with such coverage as directors and officers (D&O) liability. This can really be important for Delaware corporations that may want to take advantage of the recent change to the state’s corporate law that allows them to obtain D&O coverage from a captive. This could certainly be important if ESG drives up demand and possibly costs in the commercial D&O market. In addition to D&O coverage, we are looking at a company that has developed a product to address a company’s reputational risk related to its implementation of an ESG strategy.
In addition to some of the risks associated with ESG, there is what some may call an “anti-ESG” movement emerging in some parts of the US that could cause new risks for businesses. ESG critics cite, among other concerns, global economic uncertainty, antitrust concerns, unreliable ESG data, and greenwashing.
To address these issues, some states have enacted anti-boycott and other anti-ESG legislation. As a result, companies developing ESG initiatives must not only balance competing stakeholder interests but must deal with conflicting regulatory regimes within the US and globally, as well as conflicting investor priorities. Again, it is likely these issues will create increased demand for D&O coverage from captives.
Could ESG have other impacts on captive insurance?
ESG might increase the interest of some US owners re-domiciling their offshore captives onshore to address questions of corporate responsibility under the social pillar. In this case, a captive’s parent may determine its social initiatives are better served by bringing the captive and its assets and economic impacts to its communities in the US.
It has been suggested that captives might support its owner’s ESG programme through impactful investment of its assets. For example, one captive manager advocates that a captive may use some of its assets to invest in sustainable investment funds in support of the captive’s parent’s environmental goals.
Overall, I think ESG presents a great opportunity for captive insurance to play a role, and Delaware’s Captive Team stands ready to assist businesses in addressing their ESG issues.
Stephen Taylor is the director of the Delaware Department of Insurance’s Bureau of Captive & Financial Insurance Products. He can be contacted at: stephen.taylor@delaware.gov
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