The three pillars of ESG
The social pillar has expanded to include risk exposures such as insolvencies, cyber threats and event-driven litigation.
Environmental, social and governance (ESG) considerations might come as a trio, but it is only in recent years that the social – ‘S’ – pillar has attracted the same attention already afforded to the governance and, in particular, environmental pillars.
The ‘S’ pillar is an area of expanding commercial exposure, and one that company directors and officers need to be mindful of if they want to effectively discharge their statutory duties.
It is also a growing consideration for directors and officers (D&O) underwriters in assessing and rating risks. The D&O market has come under significant pressure from factors including rising insolvencies, increasing cyber security threats and event-driven litigation relating to inaction on issues like diversity and the threats posed by COVID-19.
These growing D&O exposures underline the importance of ‘S’ pillar issues to both underwriters and policyholders.
A closer look at the ‘S’ pillar
The ‘S’ pillar is a broad church that encompasses a wide and complex range of issues. These include employee relations, staff welfare, working conditions, workforce diversity and inclusion.
They also cover health and safety, supply chain and advertising ethics, product safety and community engagement. In addition, cyber and data security is an increasingly central ‘S’ pillar concern for companies of all sizes and in all sectors.
Each company will have a unique portfolio of ‘S’ pillar exposures, but these overarching headlines highlight the fact they are a threat facing organizations of all shapes and sizes.
Commercial importance of the ‘S’ pillar
In the way there are a large number of ‘S’ pillar considerations for companies to contend with, there are also many stakeholders to whom these issues are exceptionally important.
First is the company itself. The bottom line is that commercial organizations that put a strong focus on their ESG credentials and ‘S’ pillar activities tend to outperform those that do not.
This focus should begin in the boardroom and feed all the way down to the shop floor. It should be supported and reinforced on an ongoing basis by a company’s corporate culture.
Consultancy PwC is one of many to highlight the importance of a deep-rooted ESG ethos in corporate performance and longevity.
In research published in its 2021 paper, Beyond compliance: Consumers and employees want business to do more on ESG, it found that 92% of the 8,500+ consumers, employees and executives it had surveyed agreed companies with robust ESG commitments would outlast those without.
Companies seeking to thrive also need to find ways of attracting and retaining the best talent, and ‘S’ pillar issues have their part to play in helping them succeed.
How many people want to be poorly treated by their employer, face discrimination at work or give their all to an organization that disregards diversity?
In its research, PwC found that 83% of employees wanted to work for companies that stand up on ‘S’ pillar issues.
This view was echoed by Marsh in a recent study, ESG as a Workforce Strategy, which stated, “By 2029, the Millennial and Gen Z generations will make up 72% of the world’s workforce, compared to 52% in 2019. These generations place greater importance on environmental and social concerns than their predecessors do — and will expect more from employers on these issues.”
If organizations want to attract the best people, they can help differentiate themselves in a competitive labor market by committing to a positive and proactive ‘S’ pillar agenda.
Such activity will also endear them to customers who want to buy from organizations making a positive contribution to society. PwC found that 76% of consumers were more likely to buy from businesses that prioritized ‘S’ pillar concerns.
The list of stakeholders concerned by a company’s contribution to society extends to corporate, private and individual investors.
Corporate investors, venture capitalists and private equity funds are all under intense scrutiny and face negative publicity if their capital is used to back projects and/or organizations with anti-social connotations. Similarly, many individual investors do not want to support activity that is detrimental to society.
This means that companies looking to access such funding need to be able to show financial backers they are making a conscientious effort to support their ‘S’ pillar agenda and deliver positive outcomes beyond profit alone.
Underwriting focus on ‘S’ pillar
In addition to investors, D&O underwriters also have a keen and developing interest in the way businesses enact their ‘S’ pillar priorities.
In short, they want to know companies have their house in order. They want to ensure they have taken the time to assess and identify the ‘S’ pillar exposures they face. They want to know they have measures in place to mitigate these risks and ensure they evolve their approach going forward.
Global movements such as #MeToo and Black Lives Matter have gained significant traction and show the strength of feeling that exists against those who disregard human rights and diversity issues.
If a company is found wanting in its ‘S’ pillar activities, its reputation can be damaged at a global level within minutes thanks to digital communication. Even an allegation of wrongdoing or inactivity on an issue can make a swift and seismic impact on a company’s brand.
In such situations, share prices can quickly collapse; prompting lawsuits from disgruntled shareholders.
Digital developments have also opened the door to massive exposures in cyber and data security. In addition to the negative publicity that surrounds breaches in these areas, there can also be huge fines and an impact on customer confidence.
Where ‘S’ pillar issues are treated as second-tier concerns by companies, D&O underwriters may struggle to be comfortable with the risk they represent, impacting the rates and level of cover they offer. In addition, such risks are likely to find that cover may, if offered, come with restricted wording and increased deductibles.
Managing ‘S’ pillar exposures
So how can companies manage their ‘S’ pillar exposures, and what sort of things will underwriters look for and expect?
It is impossible to prescribe action here at a granular level for individual companies, but the following highlights the sort of conduct insurers would expect of well-managed risks regarding their cyber, employee and supply chain exposures.
Taking cyber first, does the company have a corporate officer or board director with ultimate responsibility and accountability for this area? What digital and data security measures does it have in place and what staff controls and training procedures has it enacted? Does the company have its cyber controls reviewed by a third-party organization and conduct penetration testing/vulnerability scanning?
Cybersecurity is a fast-evolving and highly sophisticated issue, so underwriters will take comfort from understanding how a company is actively monitoring developments and updating its procedures on a regular basis.
If a company has suffered a cyberattack, underwriters will also want to see how the business responded and how it subsequently improved its defenses.
Looking at a company’s supply chain, underwriters will want to know with whom responsibility lies for third-party relationships and what continual monitoring process is in place to assess each supplier.
What quality metrics are in place? Does the company commission an independent analysis of its supply chain? Is the business adhering to modern slavery laws? How is it meeting its obligations? What is it doing to support suppliers?
Companies of various sizes and in different sectors will have very diverse answers to these questions and there is no one-size-fits-all answer. But insurers will want to know they are engaging with these issues on an ongoing basis and have taken practical steps to address them.
Similarly, they will want to know that employee welfare is a central concern for company officers and directors and that detailed and forward-thinking HR policies are in place. More than this, proactive companies will have developed active company forums. They will provide well-publicized channels of complaint and run regular training on issues such as harassment and discrimination.
They will commission staff surveys and be able to show both how they address grievances fairly and how they enact subsequent measures to prevent repeat occurrences of similar complaints.
These issues are important to D&O underwriters because they want to be sure the corporate environment doesn’t lend itself to bullying, sexual harassment or discrimination.
Such problems have destroyed the reputation and value of many companies, landed them with multi-million-dollar fines and left directors and officers open to claims against them.
The ‘S’ pillar of ESG might not have been the first to find prominence, but its growing profile and importance are here to stay.
Ralph Banbury (rbanbury@cfcunderwriting.com) is the management liability underwriter at CFC.
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