Best revises ratings methodology to factor in ESG

Ratings firm AM Best has issued new guidance as to how it will factor ESG into its ratings systems.

While environmental, social and governance (ESG) information is increasingly relevant to insurance companies’ decision-making, the risks not captured by standard financial metrics.

AM Best has announced it has refined its Best’s Credit Rating Methodology (BCRM) to enhance transparency as to how it contemplates ESG risks as part of the credit rating analysis.

The firm said it will continue addressing climate risk, innovation and enterprise risk management in the assignment of a rating but added the growing importance of ESG cannot be ignored.

Best said: “Insurance companies play a unique role as it regards ESG principals, as they are risk carriers, asset managers and institutional investors. However, with no insurance industry-wide ESG standards in place, it can be overwhelming for market participants to understand how to implement and disclose ESG practices.

“For enhanced transparency, AM Best’s BCRM now explicitly identifies ESG risks for insurers in the credit rating process. How an insurance company has incorporated ESG practices into its underwriting process and management of catastrophe risk, investment policy, product offerings and scenario stress-testing are some of the discussion points AM Best raises with its rated entities. “

“Consumers are demanding that businesses take positions on societal issues and are more willing to engage with those companies that share their values,” said Stefan Holzberger, Chief Rating Officer, AM Best. “Furthermore, regulatory authorities, particularly in Europe, are compelling insurers and reinsurers to demonstrate greater transparency, and disclose how they adapt and consider ESG risks and opportunities in their operations. Failure to act on stakeholder pressure around ESG issues could lead to long-term reputational challenges for organizations and the insurance industry at large.”

Best added governance and risk culture remain key components of the ERM framework evaluation, and the firm will assess the potential for ESG-related litigation and the impact of social inflation on insurers’ financial results.

“While AM Best does not issue a separate assessment or score related to ESG, it discloses on its website in the Rating Disclosure Form that accompanies all ratings when an ESG factor is a key rating driver upon a rating action.”

It added that ESG integration can reduce operational and reputational risks as identification of ESG factors can assist companies in identifying risks and opportunities that may not be captured by conventional financial metrics.

A recent AM Best survey of insurers in Europe and Asia Pacific, “Insurers and Reinsurers: Ignoring ESG Factors Poses Reputational Risk,” showed that individual carriers are at different stages of their journey to integrate ESG factors into their businesses. The survey found that while most respondents recognise that proper understanding and integration of ESG factors is increasingly critical to the long-term viability of their businesses, there remains a marked lag between recognition and action being taken to mitigate those ESG risks.

AM Best has said it will continue addressing climate risk, innovation and enterprise risk management in the assignment of a rating but added the growing importance of ESG cannot be ignored.

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