Large companies prone to misconduct usually have to contend with three main kinds of watchdogs: government regulators and prosecutors, class action lawyers, and activist institutional investors. These parties have, respectively, the ability to impose fines, extract settlements, and bring about policy changes through shareholder resolutions.
Now it turns out that corporations are increasingly being scrutinized in another way. According to a recent article in Law360, insurance companies are paying more attention to business conduct. This is especially the case for ESG (environmental, social and governance) practices that big firms tout as evidence that they are good corporate citizens.
Underwriters providing coverage for liability claims against directors and officers are taking a more aggressive posture in two respects. First, they want to be sure any company they insure is not behaving in a way that could hurt the financial situation of the firm or damage its reputation, either of which could lead to costly shareholder lawsuits. Second, they are taking a closer look at the ESG reporting of the companies to see whether it is accurate.
Since corporations have to stay in the good graces of their insurers if they want to maintain their coverage, this trend toward stricter risk management could have significant positive consequences. For too long, insurers took a passive position toward questionable corporate conduct. They covered claims without doing much to get clients to change that behavior.
It is especially significant that more insurers are no longer taking the statements of firms at face value. The Law360 article quotes an official at insurance broker AON as saying that when it comes to ESG, “some companies just checked the box and said they have a policy in place, but that was never implemented.”
This gets to the heart of the problem with ESG policies: they are voluntary and largely unenforceable, while outcomes are often unverifiable. This makes them attractive to corporations: they can make grandiose claims about the good they are doing, and outsiders have to take their word for it.
Insurers have come to realize, Law360 reports, that “underlying litigation risk and uncertainty will continue to grow in the absence of clear definitions and common standards and regulations applicable to ESG.”
It remains to be seen whether insurers can get companies to establish clearer definitions. It may be that ESG is inherently fuzzy and that serious standards can only come from government regulators. Yet the new posture of the insurers could help discourage the most unsubstantiated ESG claims.
Hopefully, insurers will come to see that the most valid measures of business behavior should be based on metrics assembled outside the companies themselves. That is what my colleagues and I attempt to do with Violation Tracker.
The data we collect is all from regulatory agencies and court records. We ignore the statements of corporations, including those—such as the Legal Proceedings sections of 10-K filings—in which firms are supposed to own up to their transgressions. Those disclosures are almost always incomplete.
In the end, meaningful change in corporate behavior will only come about through outside pressures, not boardroom enlightenment. If insurers are serious about contributing to those pressures, so much the better.