ESG Risks and Insurance Coverage

“ESG” is a 3-pillar framework that helps stakeholders understand how an organization is managing risks and opportunities related to Environmental, Social and corporate Governance (ESG) issues.

ESG risks are becoming increasingly important concerns for companies, their employees, their investors and their customers. As a result, companies are facing more scrutiny and pressure to demonstrate progress on ESG goals. In turn, Directors and Officers are increasingly finding themselves embroiled in shareholder class actions, derivative lawsuits, and other claims related to ESG.

So, what are ESG risks? And what insurance cover is available to companies to mitigate against such risks?

Environmental

The E pillar looks at how much energy a company consumes, how much waste it discharges and the resources that it uses up.

Historically, a company’s chief concern would be whether it has breached any environmental laws and regulations. In recent years, the regulatory landscape widened. For example, the USA now requires businesses with facilities emitting 25,000 metric tons or more of carbon dioxide to report their greenhouse gas (GHG) emissions to the Environmental Protection Agency every year. Plans are afoot in many jurisdictions to introduce mandatory reporting on supply chain GHG emissions (so called Scope 3 emissions). Such reporting requirements are designed to pressure organisations to do their part to stamp out practices which are considered to be harmful to the environment.

Climate change litigation is becoming more common and it poses unique reputational risks for defendants given that consumers are increasingly concerned about the health of the planet. New types of climate related litigation are also emerging. For example, the Communication to the International Criminal Court regarding President Jair Bolsonaro’s alleged crimes against humanity which was submitted last year on behalf of the indigenous people of the Amazon has the potential to result in a landmark decision that makes way for a new international crime of ecocide to be recognised.

With the pressure to be seen as being “green” comes the risk of being accused of “greenwashing”. Greenwashing is when an entity presents false or misleading claims about its environmental performance. Presently, the Australian Securities and Investments Commission is suing pension fund Mercer Superannuation for allegedly misleading members about the sustainability of some of its investment options. This is the corporate watchdog’s first legal action for greenwashing and promises to set a precedent for future actions. 

Social

The S pillar is about how an organisation manages social relationships with employees, suppliers, customers, and the communities where it operates. It asks whether the company is sustainably invested and includes a company’s strengths and weaknesses in dealing with social trends, politics and labour rights.  Common concerns include employee diversity and employee welfare. Other concerns are data protection and privacy, wage equality, labour standards, human rights and customer satisfaction. Wider concerns may include product safety, community relations and supply chain transparency.

Companies are increasingly expected to take a stand on more social issues, but there is great scope for a company to get it wrong. This is because social issues are wildly emotive. In asking for a product endorsement from Dylan Mulvaney, a transgender influencer, in April 2023 Bud Light triggered a backlash from many consumers. This backlash caused plunging sales of the beer and has threatened Budweiser’s status as the world’s biggest beer brand.

A further issue is that the S pillar is perhaps the fastest evolving pillar. What society considers to be adequate one year may be seen as inadequate the next.

As with the Environmental pillar, companies are increasingly expected to play their part in ensuring that their supply chains are free from certain practices. For example, the UK’s Modern Slavery Act requires an organisation to publicly report on the steps that they are taking to prevent modern slavery in their operations and supply chains

Governance

The G pillar is about how an organisation is led and whether it is acting in the best interests of its stakeholders. Traditional key issues are transparency and accountability, managing conflicts of interests and dealing with ethical violations.  In recent years, the board diversity and how executives are compensated have become hot topics. 

As the scope for ESG disputes widens, there is increased interest in the insurance solutions which may be available to cover such risks.

Directors and Officers (D&O) insurance.

Directors and Officers (D&O) insurance is a type of insurance that provides protection for the personal assets of directors and officers in the event of a lawsuit. The insurance is designed to protect directors and officers from claims alleging wrongful acts, such as errors, misstatements, and breaches of duty. D&O insurance typically includes coverage for claims asserted against directors and officers, whose costs are not indemnified or advanced by the corporate entity (often called Side A cover) and also claims asserted against the entity itself (often called Side B cover).  Sometimes the policy may also provide an indemnity for situations where the company is sued together with its directors and officers (Side C cover). 

D&O insurance has a wide scope of cover and is capable of responding to many ESG risks, including the costs of responding to non-routine regulatory investigations. Indeed, many D&O policies now include specific provisions to address ESG risks, such as coverage for derivative demand investigation costs and costs of responding to governmental investigations. That said, ESG policies typically exclude claims arising out of illegal, dishonest or fraudulent conduct, pollution and physical damage to persons / property. 

Professional Indemnity Insurance

For entities which are in the business of providing advisory services, Professional Indemnity insurance may provide cover for claims arising out of actual or alleged acts, errors or omissions committed in provision of these services.  The policy may also respond to the costs incurred in responding to non-routine regulatory investigations.

Professional Indemnity insurance policies, however, almost invariably contain an aggregation clause that allows or requires similar or linked claims to be treated as a single claim. This can dramatically reduce the coverage available to an entity if it is facing claims arising out of a common set of circumstances. Further, Professional Indemnity policies also typically exclude liability for pollution events.

Other Insurance

Other specific policies like cyber insurance, employer’s liability insurance, product liability insurance and pollution insurance may provide valuable cover for ESG risks. The scope of such policies depends on their wording.

As ESG risks evolve it will be increasingly important for organisations to periodically review both their ESR risk exposure as well as their insurance cover.  The ESG risk landscape is one which is evolving both in terms of regulatory exposures but also in terms of stakeholder and consumer expectations. As the risks become more complex, the engagement of external advisors may be necessary.

Donald Spencer, Securus Legal LLC - June 2023