D&O in the Murky Waters of ESG

“ESG” is a term that is ubiquitous in our lexicon these days and can draw reactions of both hope and ire.

Standing for “environmental, social, and governance,” ESG is a framework implemented by corporations to take into account the sustainability and ethical impact of investments and business choices. While ESG may appear to be an admirable business model, potentially leading firms to take action above and beyond legal and regulatory requirements, numerous state legislatures have begun to take steps to limit ESG activity.

For example, on May 2, 2023, Gov. Ron DeSantis of Florida signed into law a bill that requires the state to invest public monies based solely on pecuniary considerations and prohibits ESG bond sales. On the other hand, the current administration at the Securities and Exchange Commission is placing great emphasis on ESG disclosures, even forming a task force focused on climate change and promotion of ESG issues. Our country is fractured on the governmental and regulatory approach to ESG initiatives and even on whether public firms should take up ESG initiatives at all. At the same time, numerous businesses and investors are making the advancement of ESG goals their highest priority in order to attract stakeholders and keep business growing. What can all of this mean for corporations and their directors and officers liability insurance programs? Is the pursuit of ESG goals a risk mitigation or risk-taking activity?

The exorbitant value of claims for failure to address environmental, social and governance impacts has shaken the D&O sector. In April 2023, the SEC Climate and ESG Task Force obtained its first settlement, against Vale, a publicly traded mining company based in Brazil, for alleged misrepresentations about the safety of its dams prior to the collapse of the Brumadinho dam in January 2019. As part of the settlement, Vale agreed to pay a total of $55.9 million, including a penalty of $25 million. In addition, in February 2023, the SEC announced a settlement with video game producer Activision Blizzard for $35 million due to allegations that the company failed to maintain internal controls regarding workplace complaints. Then, in April 2023, Johnson & Johnson agreed to pay $8.9 billion over 25 years to resolve litigation related to its talcum powder products, which were marketed as safe and effective but were allegedly carcinogenic. These types of ESG exposures can lead to high-value claim settlements. Like the D&O market response to event-driven litigation, insurers react strongly in an atmosphere of high-value claims.

Directors and officers insurance is intended to protect corporations and their corporate officers in management decision-making. However, in the murky waters of ESG, it is not at all clear if building a corporate ESG program supports or hinders officers’ fiduciary duty to maximize shareholder profit. This is, in part, due to legal jurisdictional differences in addition to the lack of clear regulatory standards. However, no matter the location, a corporation’s D&O insurance program will bear the financial risk of ESG-related decisions, and insurers must take into account how a firm is addressing ESG risk. Lydia Miller, global underwriting and product analyst at Allianz, told Board Agenda in January, “Companies with strong ESG frameworks and governance will likely face insurers more willing to offer capacity.” Eric Jesse, partner in Lowenstein Sandler’s Insurance Recovery Group, says on a YouTube video that insurers are going to probe deeply into a company’s ESG efforts and compliance with ESG-related disclosures during the underwriting process. “And, as claims come in, insurers may even try to avoid coverage for these ESG-related lawsuits by claiming that companies made misrepresentations during the underwriting process on their application with respect to ESG,” says Jesse.

Ultimately, in today’s market, companies cannot avoid the impact of ESG, even in those jurisdictions of the United States where state governments are taking an anti-ESG position. Regulators, shareholders and stakeholders are holding corporate feet to the fire to ensure that companies are not only truthful in their statements about ESG goals but that they also are pursuing corporate initiatives related to things like climate; diversity, equity and inclusion; and corporate oversight. It may even make a company a more attractive D&O risk if it can present unique and concrete steps it has taken to foster ESG goals. Firms should continue to make attention, clarity and accuracy a top priority in presenting ESG planning during the D&O underwriting process. While the claims activity may remain unpredictable, centering attention on ESG is recommended for many insureds during the underwriting process in order to help achieve desired protection with a D&O program.