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Using captives for ESG risk? How to get it right

By Peter Carter and Adrien Collovray | June 29, 2023

How can you be confident you’re taking the right ESG risks to commercial markets and retaining the appropriate risks via a captive?
Captive and insurance management solutions|Climate|Medioambiental|Risk & Analytics
Climate Risk and Resilience

“Can we insure ESG risks and does it make sense to use our captive?” A question risk managers are facing with increasing frequency as pressure to address environmental, social and governance (ESG) factors from regulators, investors, customers and activists builds. But how can you make sure you’re taking the right ESG risks to commercial markets and retaining the appropriate risks via a captive?

In this insight, we look at actionable steps to enhance your ESG profile through a diagnostic approach, integrating enterprise risk management (ERM) with a captive programme that’s both systematic and quantifiable.

Understand your ESG risk

We often hear ‘ESG’ being discussed as single, monolithic risk, with limited insight on how potential mitigation and adaptation measures would improve your profile relative to peers and your industry. This can result in pockets of well-intentioned ESG related activity by different business functions or leaders. These may be driven by best practice and strong evidence, or by individual values and gut instinct. They may or may not prove effective and can be piecemeal and unsystematic.

That said, there is no single standard for defining the universe of ESG risks.

For our part, WTW has developed ESG Clarified, an ESG risk scorecard for organizations. This uses data from multiple sources, including:

  • MSCI, which provides a financial view measuring a company’s resilience to long term financially relevant ESG risks
  • Aniline, which scores nine key metrics important to employee sentiment
  • Polecat, which evaluates public online and social media related to specific keywords and sentiment (positive and negative)
  • WTW proprietary data, driven by insights from our advisory work to evaluate your performance across the three ESG pillars relative to your peers in the same industry.

This helps identify areas of relative strength and weakness and can help prioritise actions. The scorecard can be refreshed regularly to track and measure progress.

Understand your risk tolerance

A key aspect when determining an appropriate a risk financing strategy is to confirm what level of financial volatility you can sustain before impacts are felt in business, such as on usual operational decisions like paying bonuses or investing in capital projects. Similarly, robust risk tolerance analysis together with quantification of your ESG risks helps ensure alignment to your organization’s financial priorities.

Understand captives as ESG risk enablement vehicles

Once you have reviewed your ESG risks using the methodologies of enterprise risk management (ERM) to define, quantify, and prioritize key ESG risks, and to also clarify your risk tolerance, you can now consider what role a captive can play in your overall ESG risk management program.

A captive could, for example, allow you to retain risk or to access capacity in different ways through parametric or structured solutions, or to access capacity that’s not available in primary markets. This is useful for organizations unable to reduce their exposure to oil and gas or coal risk, which precludes them from accessing primary markets, to give one example.

Your captive can help fund targeted mitigation and adaptation initiatives and incubate new and emerging risks, as well as provide protection against reputation and litigation risk that could arise if the business faces claims around its ESG credentials not matching its public pledges (for example, so-called ‘greenwashing’).

Alternatively, a captive solution might help you transform a volatile revenue stream into a more stable one. This could be helpful to investors in renewable energy production where you need to demonstrate to banks how you’ll repay project financing.

Using captives to address ESG isn’t only about enabling efficient risk management, it can drive ESG opportunities too. For example, we’ve seen multinationals use captives to provide employees with harmonious access to medical benefits across territories. This not only addresses risk related to its people (part of the ‘S’ of ESG), but also positions the business to compete for talent globally.

Next steps on using captives for ESG risk management

A captive may well be appropriate in your ESG risk management program, allowing you to incubate and pre-fund those risks difficult to find traditional insurance capital to sit behind. But this process must begin with understanding your ESG priorities and applying the rigours of ERM using quantitative and qualitative tools to take the right steps within your risk tolerance.

You also need to deploy the same tools and tactics to continually check the balance of your program between those ESG risks you should take to market, and those it’s more efficient to retain as markets, risks, and your organization evolve.

As risk managers are increasingly scrutinized and challenged on how they are managing ESG risk, particularly in comparison to peers, they need to offer internal stakeholders appropriate visibility around ESG risk. More analytical and diagnostic approaches to ESG, drawing upon third party data can clarify the areas you should prioritise and how to measure success.

For support to develop smarter way to efficiently manage ESG risk, get in touch.

Authors

Global Head of Captives and Insurance Management Solutions

Director- Global Captive Advisory

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