Parametric insurance, which has long been popular in disaster recovery, is gaining steam as a proxy for proving the effectiveness of ESG programs. Nir Kossovsky and Denise Williamee of insurer Steel City Re explore details of this novel ESG solution.
New SEC rules, market trends and DOJ guidance have put compliance at the nexus of corporate reputation management. Whether it’s risk associated with ESG claims and disclosures or pay-for-performance practices or strategies undertaken by executives to prevent mission-critical reputational risk, compliance officers are now enmeshed in a range of high-profile public-facing issues related to topics like diversity, cybersecurity, safety and more.
The playbook is becoming clear. Compliance and risk management teams need to develop effective systems for understanding the expectations of key stakeholder groups, analyzing the company’s ability to meet them and measuring and protecting against the risk of disappointment.
One emerging insurance solution is to transfer ESG and reputation risks through specialized parametric ESG and reputation insurance products, which include an underwriting process that can be used as a basis for authenticating effectiveness of the risk strategy for stakeholders — whether they be regulators, enforcement agencies, customers, employees, investors or others.
Insurance-based authentication — a regulatory lynchpin — is a recent innovation made possible by parametric insurance solutions. Let’s explore parametric insurance and how it’s gaining adoption as a reputation risk management tool.
What is parametric insurance?
Rather than cover the value of a loss, parametric insurance covers a model of the value of a loss. For example, in the event of a total loss of an automobile, the coverage value of the loss may be determined by several parameters — age, make, model, mileage and Kelley Blue Book value tables.
Individuals in the disaster insurance market may be familiar with parametric insurance, as it’s a popular type of coverage that holds the promise of getting payments to policyholders much more quickly than traditional insurance coverage.
Parametric insurance is available for many complex risks that are hard to underwrite or adjust but for which there is ample actuarial data for modeling. For example, wind or rain damage covered parametrically would be triggered by specific values of windspeed and a floor of rainfall inches. Crop loss covered parametrically would be triggered by an index composed of temperature values and ceiling of rainfall inches.
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How does parametric insurance work for reputation risk?
Instead of being triggered by environmental factors, reputation loss covered parametrically would be determined by a synthetic index comprising the variables of a reputation value model. This could include measures like expectations of future economic performance, market capitalization and index volatility.
A reputational loss would then be triggered by, say, failure of an expected board oversight process (such as a major ethics breach), negative media coverage and a sustained drop in the organization’s reputational value index.
How can companies use parametric insurance to prove their ESG bona fides?
Parametric insurance enables organizations to demonstrate simply and convincingly that a solid process for mitigating risk exists and that it has been vetted and validated by an outside party, using clear and straightforward metrics and that the insurer is willing to put real dollars behind their judgment. That allows for ease of analysis by external stakeholders, potentially including regulators.
Our research has found that companies with strong ESG and reputational risk protection strategies have seen their stock prices rise 5% above the market within two weeks of a reputational challenge. We also found that stock prices of firms that managed, validated and publicized ESG and reputation risk management strategies on average gained 9% over the subsequent seven months after a precipitating event, while firms that failed to do so lost 13% of their stock value over the same period — and underperformed their peers by an average of 23%.
The combination of social media, economic uncertainty, populist politicians and aggressive regulators has put companies into a public spotlight on issues they’ve never faced before. The inclination of corporate leaders to make corporate citizenship pledges and chase ephemeral, ill-defined ESG ratings has exacerbated reputational risk. The current environment presents challenges, but also brings with it opportunities — to refine internal systems and responsibilities and elevate the reputation and market value of companies that avail themselves of these risk strategies.