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Bringing a strategic approach to managing climate risk and resilience is, in one substantial way, no different from any other business issue facing insurers. If, as a business owner or investor, you really want to get things done, the overwhelming evidence is that executive level rewards need to be aligned with the strategic objectives you want the Board to deliver.
Pretty much since discretionary pay and longer-term incentives have been a thing, that realisation has driven an executive remuneration culture that has principally focused on profit maximisation or similar financial objectives. Today, however, there is increasingly a subtle, but significant, difference across all sectors but in financial services in particular. Short-term financial performance matters, of course it does, but it comes with an added focus on ESG (environmental, social and governance) factors, and what is sometimes termed “quality of earnings”.
Jam today, jam tomorrow
In essence, what this means is that more and more of today’s investors – and, importantly from an insurance perspective, financial services regulators such as the Prudential Regulation Authority and the Financial Conduct Authority too – not only want to see Boards delivering jam today, they want to know it will be available tomorrow. They want notably to see business conducted in a way that is more sensitive and resilient to climate risks – be they physical, transitional or liability in nature.
The questions therefore increasingly staring insurers in the face are: ‘How does our executive pay reflect that? Do our senior level rewards encourage behaviours that are compatible with our projected climate risks?’
…more and more of today’s investors – and, importantly from an insurance perspective, financial services regulators such as the Prudential Regulation Authority and the Financial Conduct Authority too – not only want to see Boards delivering jam today, they want to know it will be available tomorrow.
Taking our recent survey of companies’ readiness for Task Force for Climate-related Financial Disclosures (TCFD) as a guide, these are questions that not too many companies have addressed in any substantial way thus far. This showed that while financial services companies (including insurers) are certainly some way ahead of non-financial organisations in acting or thinking on these questions, less than a quarter have already made climate-related adjustments to executive pay or will be ready to make them in the next 12 months.
One of the main reasons behind this is that deciding on such adjustments is something of a chicken and egg problem. The executive compensation framework relies on company climate plans that many don’t have fully mapped out – or certainly not at board level anyway – because they involve difficult questions they can’t necessarily answer. Issues such as how accountability matches up to incentives through metrics and weighting are also still being worked through.
True green
Yet, it’s becoming clearer that trying to answer such questions, say around the impact of future climate scenarios on the business, albeit perhaps in an imperfect way to start with, shows positive intent to investors and regulators alike. What insurers certainly have to avoid though is the temptation to add the façade of a ‘green tint’ to how bonuses are measured, decided upon and awarded. This will become obvious very quickly, with the likelihood of penalties from lost investment and/or regulatory and stakeholder sanctions only set to rise in the years to come.
…it seems to us that executive pay has to be part of insurers’ climate action plans. Indeed, its inclusion might even act as the blue touch paper for igniting a wider strategic debate about climate risk and resilience that perhaps wouldn’t otherwise happen, but which is increasingly necessary to manage the systemic nature of the composite risks.
For insurers, such a façade is potentially doubly unproductive anyway. Thinking about the various ways in which an insurer is affected by and can influence climate risks, they permeate throughout the organisation. Everything from the equities, bonds and infrastructure in which they might choose to invest, through underwriting policy and how insured risks are priced, to whether or how a risk is deemed insurable. Since many of the metrics that underpin insurance operations will increasingly need to take green factors into account anyway, a richer green seam can start to feed naturally into the measures that can determine executive rewards.
Insurers that miss or fail to act upon this link between how their own operations fare under climate change scenarios and senior rewards also risk accusations of ‘greenwashing’ and hypocrisy. As major investors in their own right, insurers will increasingly find themselves in the position of voting on other organisations’ sustainable activity and drawing extra scrutiny from that. And that doesn’t take into account considerations about whether the Board is appropriately monitoring its underlying longer-term exposure to climate-related physical, transition and liability risks in the investment portfolio – although it looks like regulators will certainly have more to say on that1.
Ignite strategic analysis
Going back to the assertion that ‘if you want something done, reward your senior executives in the right way’, it seems to us that executive pay has to be part of insurers’ climate action plans. Indeed, its inclusion might even act as the blue touch paper for igniting a wider strategic debate about climate risk and resilience that perhaps wouldn’t otherwise happen, but which is increasingly necessary to manage the systemic nature of the composite risks.
Better to give it a go than do nothing. Sure, there will be metrics to choose, targets to set and measurement methods to implement, but these can be adapted over time – in the same way that the climate challenge will inevitably evolve over time. (Read further on this topic: Combating climate change through executive compensation.)
1 Note that on 9 November, the UK joint regulator and government Taskforce for Climate-related Financial Disclosures (TCFD) Taskforce published an interim report and accompanying roadmap signalling the intention to make TCFD-aligned disclosures mandatory across the economy by 2025, with a significant portion of mandatory requirements in place by 2023) – see https://www.gov.uk/government/publications/uk-joint-regulator-and-government-tcfd-taskforce-interim-report-and-roadmap
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