House Financial Services Subcommittee Issues Testimony From R Street Institute Program Director Theodorou
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Chairman Davidson, Ranking Member Cleaver and members of the Subcommittee:
Thank you for holding today's hearing on "How Mandates Like ESG Distort Markets and Drive Up Costs for Insurance and Housing," and for the invitation to testify. My name is
Today's hearing is timely because environmental, social and corporate governance (ESG) factors have the capacity to influence insurers' performance, and by extension the availability and cost of insurance for consumers and businesses. Government mandates impacting the insurance industry destabilize insurance markets, leading to limited choice for consumers and businesses, and create higher costs. The imposition of ESG-related mandates, albeit well-intentioned, limit choice, reduce competition and drive up prices.
In some ways, discussion about how ESG factors impact the industry may be considered moot or unnecessary. Taking ESG considerations into account in insurance coverage and investment decisions is not new. It was evident well before ESG became an established concept in the 2000s. It is an element of sound risk management, and the insurance industry is fundamentally about managing risk. Such industry-led approaches to ESG are generally not a concern. The problem is when government imposes its perspective on ESG through mandates on the private sector.
Each of the three elements of ESG is familiar to insurers. On the "E" of ESG, insurance companies have been, and continue to pay, for losses caused by weather and climate catastrophes. This is a large part of what they are in business to do. In 2022, insurers paid out
Adverse Impact of Government Mandates on Insurance
Among the ways government or regulatory mandates create adverse consequences, with higher costs ultimately borne by consumers, are government monopolies on certain insurance products and intervention in how insurers are allowed to calculate rates and premiums. For example, workers' compensation insurance, which is required, is a monopoly in four states--
In
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1 "Facts and Statistics:
2 "Monopolistic state funds,"
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In states where the insurance commissioner is elected, rather than appointed by the governor, commissioners may be more likely to pursue populist agendas. An example is
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3
4
5
6 Ibid.
7 Ibid.
8 Ibid.
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10
11
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If government-mandated ESG considerations require insurers to insure certain risks or require them to invest in certain firms, the market is disrupted. When such government intervention prevents insurers from insuring certain risks or investing in certain firms, insurers have less power, and the market is disrupted in ways that ultimately lead to higher costs for insurance buyers.
Negative Consequences of Government Mandates
There are three main ways the insurance industry may be affected by ESG considerations:
1. Availability of insurance coverage may be reduced
2. Cost of available insurance protection may rise
3. Insurers' investment portfolios may underperform
Examples of potential ESG-related impacts on insurance cost includes insurers announcing they will not underwrite risks related to construction and operation of new coal-fired plants.12 If other insurers adopt this policy, coal-fired plants would have to obtain coverage from the excess and surplus lines insurance marketplace, where insurance premiums are higher.
The property and casualty insurance industry holds
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12 "
13 S&P Market Intelligence/Capital IQ as of
14 Ibid.
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Market Disruption
The operations of insurance companies are remarkably complex, but their core activity is to allocate their capital to the risk they assume. They charge premiums commensurate with risk magnitude. Past losses and claims payments are signals that help inform insurers about the magnitude of risk. If government bodies mandate rates or rating factors that insurance companies may or may not incorporate into their pricing, rate is decoupled from risk, weakening the signal and attenuating the ability of the market to function efficiently. If government intervention is extreme and insurers are coerced to price their policies with little regard for risk magnitude, they may abandon markets where this happens.
If ESG considerations or ESG investing drive insurers to make coverage, pricing or investment management decisions in ways contrary to sound risk management, insurers are less able to fulfill the three basic ways insurance plays a critical role in the economy. These are: 1. To pay claims to individual and business policyholders experiencing unexpected losses
2. To enable businesses to take risks they would not take on in the absence of insurance
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15 Ibid.
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17
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3. To purchase for their investment portfolios municipal, government and corporate bonds that support construction and maintenance of the country's and states' critical infrastructure, and respond to corporate America's need for capital Because the insurance industry plays such a critical role in the economy, external forces that may disrupt the industry deserve serious consideration. Exploration of the potential impact of ESG on insurers is therefore a timely and important undertaking.
Defining ESG and ESG Investing
One reason that ESG-related discussions have become polarized and heated is because there is a lack of agreement on the actual definition of ESG. It is an umbrella term that has different meanings for different people. To many on the left, it is a vehicle to achieve environmental and social objectives.18 To many on the right, it is a way for "woke" radical elements to drive a liberal agenda into the investment sphere.19 Among pro-ESG proponents, there are further distinctions, such as whether ESG considerations enhance pecuniary returns. However, proponents also want to amplify values or impact-driven ESG approaches, where some pecuniary gain is given up to attain non-pecuniary objectives.20 The term "ESG investing" is sometimes used as an alternative to ESG.21 "ESG investing" is, however, also a fraught term that needs to be defined. It suggests that ESG is an investment methodology. Investment managers typically follow one of two main methodologies in selecting stocks. Fundamental analysis focuses on value by looking at financial metrics, such as price-to-earnings ratio, price-to-book ratios and debt ratios. Technical analysis, by contrast, focuses on share price movement, looking at charts of stock performance to identify signs or triggers for future price movement and opportunities to buy or sell. If one defines "ESG investing" as making investment choices based on the environmental impact of the investment at the expense of looking at other factors, ESG investing is not new, but is just a nuanced term for sustainable investing or socially responsible investing--which results in putting a premium on attaining social ends.
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21 Rossetti. https://www.rstreet.org/wp-content/uploads/2022/06/2Final_SEC-Climate-Disclosure-Rule-Final-Philip-Rossetti-.pdf.
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According to rating agency
Unintended Consequences
Today's heightened interest in ESG has led to the mushrooming of a cottage industry providing ESG consulting services, ESG ratings assigned to individual companies, and categorization of companies as either "brown" or "green." Brown companies generate high levels of greenhouse gas emissions, and green companies produce low levels of greenhouse gas emissions. A recent study by scholars at
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22 "What is the difference between ESG investing and socially responsible investing?," Standard & Poor's Global,
23
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Pro-ESG versus Anti-ESG
The discussions and debates surrounding ESG issues have led to polarization of positions, with both sides adopting extreme views. In addition to extreme positions, there is a spectrum with varying degrees of support or opposition to ESG investing.27 Ardent pro-ESG proponents are found in radical environmental circles. At this end of the spectrum, one group maintains we are in the middle of the "sixth mass extinction"--termed the Anthropocene extinction--caused by human activity, which will result in the extinction of a million species.28 This group holds that failure to address environmental concerns immediately will lead to the extinction of humanity and other forms of life. At the other end, an extreme anti-ESG position that made its way into a company's proxy statement maintains that the
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26 Ibid.
27 "Navigating State Regulation of
28 "Extinction Rebellion - Why Rebel?," Extinction Rebellion, last accessed
29 "Notice of 2023 Annual Meeting of Stockholders and Proxy Statement," Alphabet,
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Anti-ESG in the States
Several states have adopted anti-ESG legislation, including
Government mandates on insurers, whether ESG-related or not, introduce coercive or restrictive controls on insurers. Mandates erode choice and competition and inflate cost. Both extremes of the ESG debate distort insurance markets and can generate pressure to raise insurance rates. A hard position advocating attainment of non-pecuniary goals at the expense of insurer profitability dents returns, leading to higher insurance premiums. A hard anti-ESG position prevents insurers' investment managers from being cognizant of material risks to insurers' financial health. Whether insurers' investment managers follow pro-ESG or anti-ESG frameworks does not dilute their fiduciary duty to make investment decisions in the best interests of insurers. Mandates in insurance, including ESG-related mandates, militate against competitive markets and stable pricing environments.
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30 "Texas Anti-ESG Legislation Targets Insurers and Pensions," Cobb & Counsel,
31 Ibid.
32
33
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Thank you for holding this hearing, and thank you for your consideration of my views. I look forward to any questions you may have.
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Original text here: https://docs.house.gov/meetings/BA/BA04/20230714/116212/HHRG-118-BA04-Wstate-TheodorouJ-20230714.pdf
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