More Than Global Warming

Photo: iStock.com/SasinParaksa

If someone suffers a major health event, such as a heart attack, doctors rush to stabilize the patient, help them recover and eventually work on understanding the underlying causes of the medical condition. Often the acute episode reflects diseases that are caused or aggravated by a person’s lifestyle, aspects of which include a poor diet, smoking, overexposure to the sun or lack of exercise. Medical systems have been working hard recently to educate the public on healthy lifestyle choices while technology, such as smartwatches or apps to track food intake, can help people achieve better health.

The climate change issues faced by humanity have some commonalities with medical conditions. Acute events, such as massive wildfires or large tropical cyclones, require immediate action to save lives and restore property, but they are often symptoms of social trends more fundamental than greenhouse gas emissions. In fact, climate change is but one aspect of our ecological footprint, which includes loss of biodiversity, agricultural challenges, plastics pollution and rising water shortages.

Fortunately, just as smartwatches can help people monitor their exercise levels, new technologies can monitor contributors to ecological damage from things like melting land ice. And just as exercise and diet can help lower the risk of cardiovascular disease without ruining people’s lifestyles, there are many social changes that can be implemented that promise to improve planetary health without major damage to overall economic or social well-being.

Changing habits can be very disruptive at both the individual and societal levels. Individuals may find going to the gym an unpleasant disruption to their morning routine, but the payoff in health is usually worth it. Transitioning to a more sustainable world will involve difficult changes that will adversely affect parts of society, and it is critical to understand those adverse effects and mitigate them. For example, academic arguments that there will be a net increase in employment from decarbonization are of little comfort to those whose jobs are lost or whose communities decline when energy sources such as coal are discontinued.

Mindset

Transitioning from treating symptoms to treating the disease requires those working in the climate space to adopt a mindset focused on a holistic view of the world as an integrated social system. The need for this has been illustrated by the COVID-19 pandemic:

• The coronavirus is global. In an age of international travel and complex global supply chains, no one country can manage this problem alone. Viruses, like carbon, do not respect national borders.
• Problems in one area, such as COVID-19 patients overwhelming health systems, can have knock-on effects elsewhere, such as in a decline in treatment of other illnesses, with potential long-range consequences for health.
• Recent past experience is not necessarily sufficient to understand future risk. Scenario planning and mapping past events (such as the Spanish flu pandemic) onto current conditions is essential.
• Technology can be both a blessing and a curse. The speed with which vaccines have been developed and the utility of contact tracing apps are examples of the former, while the rapid spread of disease on airplanes and economic dependence on high-risk activities, such as going to pubs, are examples of the latter.

In the case of climate risk, we need to move beyond thinking of the problem as simply an issue with carbon emissions or rising seas, to thinking about the sustainability of the social system. Wikipedia has a concise definition of systems theory:

“… the interdisciplinary study of systems. A system is a cohesive conglomeration of interrelated and interdependent parts which can be natural or human-made. Every system is bounded by space and time, influenced by its environment, defined by its structure and purpose, and expressed through its functioning.”

Applying systems theory to the problem of climate change quickly leads to thinking of the problem in terms of environmental, social and governance (ESG) criteria and sustainability. Investopedia describes ESG as:

“… a set of standards for a company’s operations that socially conscious investors use to screen potential investments. Environmental criteria consider how a company performs as a steward of nature. Social criteria examine how it manages relationships with employees, suppliers, customers and the communities where it operates. Governance deals with a company’s leadership, executive pay, audits, internal controls and shareholder rights.”¹

It defines sustainability as:

“… meeting the needs of the present without compromising the ability of future generations to meet their needs. The concept of sustainability is composed of three pillars: economic, environmental and social—also known informally as profits, planet and people.”²

Thinking of these issues in the context of sustainable complex systems helps frame the climate risk problem in a way that leads to treating the underlying drivers of climate risk. As experts in risk, actuaries are poised to play an increasingly important role in improving sustainability.

Measurement Leads to Management

The U.K. government recently commissioned an independent review of the relationship between biodiversity and economics. The report, “The Economics of Biodiversity,” argues that we must consider ourselves part of nature, an asset that we have failed to manage sustainably. Among its many conclusions is that we need to change our measures of economic success to include natural capital accounting. Creating better measures of wealth would overcome limitations in current metrics like gross domestic product (GDP), which do not include externalities, such as pollution or depreciation of nature. Flawed metrics lead countries to pursue unsustainable policies, so evolving the tools used to manage government policies is a necessary part of tackling climate risk. This thinking is a logical extension of systems theory and a natural place for the actuarial profession to contribute.

Actuaries and Climate Risk

Many leading actuarial organizations, including the Society of Actuaries (SOA), have committed considerable resources to climate, including education materials, research dedicated to climate change and risk, and this recent series of articles in The Actuary. The Institute and Faculty of Actuaries (IFoA) in the United Kingdom has also brought climate change to the forefront, having developed educational materials and thought leadership papers on sustainability. Actuarial organizations in Australia, Canada and Europe also have been active. The International Actuarial Association (IAA) has produced a number of climate risk papers and regularly participates in consultations with various supranational organizations, such as the Sustainable Insurance Forum, International Association of Insurance Supervisors and the United Nations.

To expand our horizons into this space, actuaries must evolve both our thinking and education. In many traditional areas of actuarial work, the focus is on data—usually generated by financial firms—and the actuary is often the “expert in the room” on topics such as valuation, dynamic financial analysis or pricing. Traditional actuarial education focuses on math, computer literacy, financial institution accounting, insurance and so on. Problems often are solved by breaking them down into discrete parts and applying complex mathematics to analyze large, but specialized, bodies of data.

Climate risk requires a much more diversified skill set and educational background. Problems involve complex systems, such as weather phenomena or national economies. Data often comes from sources external to the financial firms for which actuaries traditionally work. Collaboration with a diverse set of experts, including climate scientists, econometricians, catastrophe modelers, agronomists, hydrologists and engineers, is essential. Education requires a general understanding of many topics not on the actuarial examination syllabus.

Actuarial organizations are working to develop education pathways in climate risk. For example, the IFoA has created a webpage entitled, “Sustainability and Lifelong Learning,” which contains links to many excellent resources. Climate Change – Information Note for Appointed Actuaries, by the Actuaries Institute Australia provides a summary of how actuaries should consider climate risk when reviewing the financial condition of insurers.

Increasingly, actuaries are being called upon to consider various sustainability issues, including:

• Financial disclosures under guidelines promulgated by the Task Force on Climate-related Financial Disclosures (TCFD)
• Climate risks and opportunities in enterprise risk management (ERM) frameworks
• The suitability of reinsurance arrangements in light of changing climate risk
• Business strategy in light of financial services firms adopting ESG guidelines
• Regulatory requirements
• Product development and pricing for new types of risk, including renewable energy, electric vehicles and “green” supply chains
• Sustainable investment policies

Examples of Sustainability Issues Related to Climate Risk

Most people think of climate risk as physical risk from weather and transition risk from decarbonization. Considering sustainability leads to a wider range of challenges whose solution(s) involve actions that can benefit the climate, economy and social well-being at the same time. Of course, transition changes will involve some disruption to current industries, just as automobiles replaced the horse-drawn carriage industry and Netflix replaced video rental shops. Those disrupted by change must be helped by those who benefit from it.

Here are some examples of transformations that can advance sustainability:

• Telecommuting. COVID-19 has demonstrated that many workers can do their jobs remotely without the need to consume energy moving from their homes to an office each day. While many jobs cannot be done remotely, increasing the proportion of people who telecommute at least part of the time can lower energy use, improve health and enhance productivity. Reduced demand for commercial office space lowers the need for carbon-intensive building materials. Adverse consequences include job losses in service industries serving central business districts (CBDs) or mental health issues arising from the loss of social interaction, especially among people who live alone.
• Telehealth. COVID-19 also has shown how modern technology can help doctors reach patients without the need for as many in-person office visits. Increasing the use of telehealth can improve access to care in rural or disadvantaged areas, reduce energy consumption in transport and increase doctors’ productivity. Adverse consequences could include reduced levels of care or misdiagnosis.
• Land use planning and building codes. There is significant room for improvement in where and how buildings are constructed. Singapore, for example, has promulgated a Green Building Masterplan, designed to have 80 percent of buildings (by floor area) made green by 2030 with reduced energy consumption and other sustainability features. Planning and codes also can help with locating buildings away from areas with potential hazards such as flooding, in turn reducing the need for rebuilding after catastrophes.
• Waste reduction. Reducing waste can have significant social benefits with relatively few adverse consequences. China has embarked on a major food waste initiative called Clear Your Plate, most locations in Australia have banned the use of plastic bags, and the European Union has mandated manufacturers of electronic equipment make their products easier to repair and reuse. Such actions involve a degree of inconvenience, but they offer substantial benefits to society.
• Water use. There are major opportunities to reduce water use in agriculture, manufacturing and residences. For example, Israel has pioneered the use of drip agriculture, which is used in 75 percent of Israeli agriculture and has allowed the country to produce most of its own food and export significant amounts despite the country being in an arid location. The technology has expanded to more than 100 countries.

Concluding Thoughts

Countries are at different points in the journey regarding climate risk, greenhouse gas emissions and human activity. Many have reached a consensus on the science and moved toward decarbonization and “net zero” targets consistent with the Paris Agreement, while others continue to debate the science and what, if any, actions should be undertaken. Personally, I recognize this divergence of views and have tried to focus this article on ways to think about the problem holistically in terms of sustainability and how actuaries can be a part of whatever solution(s) are appropriate in various countries.

A transition to a more sustainable world is happening and represents an economic transformation similar in importance to the Industrial Revolution and the internet. Evidence of change is everywhere. The cost of renewable energy continues to fall and is now competitive with fossil fuels. China is investing enormous sums in electric vehicles and high-speed train networks, promising net zero emissions by 2060. The European Union, Japan, South Korea, Australia and New Zealand have endorsed various versions of net zero emissions by or around 2050. The Biden Administration has pledged to make climate a focus of U.S. federal policy. ESG is being adopted, sometimes under pressure from shareholders, by an increasing proportion of publicly traded companies. Plastic packaging is being phased out in many places. Sustainable agricultural practices, such as “no-till,” are becoming increasingly popular. All of these things, and many others, will result in an inexorable shift in our lifestyles on Earth.

Common themes in the transition to a more sustainable planet include the importance of systems thinking, having a stochastic mindset (e.g., the future is a range of possible conditions), being able to understand tail risk, developing better measurement tools, and doing long-term planning, including comparing costs and benefits over multidecade time horizons. Actuaries have unique skills to tackle these challenges, and environmental sustainability can help sustain the profession in the future.

Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.

Copyright © 2021 by the Society of Actuaries, Chicago, Illinois.