Policyholders’ subjective beliefs: approaching new drivers of insurance ESG reputational risk

Abstract Firms, insurance companies, pension funds, and broadly speaking the international community focus already their engagement activities on environmental, social and governance (ESG) issues since it can create long-term shareholder value, by determining the future performance of markets. Indeed ESG criteria adoption has multiple positive dimensions and outcomes, meanwhile, the analysis of the risks related to sustainability is already uncommon. In this paper, we provide a formal theoretical valuation system on ESG reputation, i.e., the reputation or the gain in confidence produced by possession of a positive reputation compared to the lack of one when the ESG criteria are integrated into the business analysis. In particular, we model the ESG reputational risk by means of the paradigms of behavioural finance. We define the ESG reputational risk by subjective probabilities framed in a probability function based on preferences set of the potential trustees, such as actors or objects in whom others may seek to place trust. Furthermore, we compute the sustainability premium or discount, which measures the economic impact of the good or bad reputation due to ESG investments. One of the approach’s main features is the flexibility coming from the opportunity to assign a given analytical form of the utility function describing the trustor’s preferences. From an operational point of view, our results should encourage the firms and other institutions to accurately evaluate the reputational risks related to ESG investments.