Actuaries and Climate Change

Climate change increasingly affects every area of life and finance—and actuaries are responding individually and collectively. In the United States, that response includes the Actuaries Climate Index, the Catastrophe and Climate Strategic Research Program and the recently launched Society of Actuaries (SOA)–Milliman Climate Risk Certificate Program. Internationally, there is even more. From the U.K. Institute and Faculty’s 2017 Risk Alert that formalized the profession’s recognition of climate as a key risk factor to the International Actuarial Association’s series of papers, among a long list of other global initiatives, the actuarial profession has explored the topic of climate risk in a multitude of ways.

Given the scale of interest in the topic and the massive potential impact on insurance, pensions and investment, this should surprise nobody. Actuaries, of course, are just some of the people interested in climate change. The core of our expertise is financial risk, not climate science. Climate science is a specialist area and a complex one at that. However, we bring something unique to the table in applying our particular skill set to the emerging questions around the implications for the financial sector. And I believe that we, as a profession, have two great strengths—and one characteristic that could hinder us if we are not self-aware. So, let’s start with the strengths.

The Cold, Hard Facts

Climate change is an emotive subject; general discussion can be highly charged. So, the actuarial focus on logic and analysis is valuable here. Fact-driven, grounded, dare we even say unemotional (bring on the stereotypes): These, in my experience, can help to prevent feelings from running too high.

We’re not climate experts, but we are experts in the objective application of scientific data to the financial field. Moreover, the actuarial discipline can be a valuable defense against social intuitionism—what American social psychologist and author Jonathan Haidt has called “the emotional dog and its rational tail”—a pitfall to which we all, as humans, are prone.

A Profession With a Purpose

The second big strength is professional integrity. Our work serves a broader purpose, as noted, for example, in the SOA’s value proposition, which ends with the goal of achieving “the improvement of financial outcomes for individuals, organizations and the public.”

For example, I often have found myself arguing that best practice in environmental, social and governance (ESG) investment must mean both best practice in investment and sustainability: a recognition of the broader context within which we operate. Peter Drucker, who has been called “the founder of modern management,” wrote 50 years ago: “Management is a social function. It is, therefore, both socially accountable and culturally embedded.” He noted in his 1973 book, Management: Tasks, Responsibilities, Practices: “Any institution exists for the sake of society and within a community. It, therefore, has to have impacts, and one is responsible for one’s impacts.”

Accepting the responsibility to which Drucker refers can mean challenging those who would argue (with American economist Milton Friedman) that “the social responsibility of business is to increase its profits.” If we stop there, in my opinion, we fail ourselves and society. Businesses should indeed seek to increase their profits, but not at any price. Even Friedman accepted that externalities—third-party negative impacts resulting from business activity—justify government intervention. Climate change is an externality of exceptional scale.

So I would argue that we must challenge the notion that we have a fiduciary duty to pursue gain irrespective of the impacts. In a powerful 2019 article on the dynamics of markets, sustainability researcher and writer Duncan Austin described how corporations may be “legally bound to pursue self-interest in a way that we would never think of legally binding real individuals, and which no non-sociopath would ever accept.”

As we consider this wider purpose and these impacts, we would need to be sensitive to the time horizon mismatch that is a feature of climate analysis.

Know the Limits

So far, so encouraging. Actuaries have a part to play and a perspective that can be valuable working alongside scientists, policymakers and others to formulate better responses at the policy level and in the ordinary course of our businesses. But there is a point to watch, a potential Achilles’ heel. In certain circumstances, the same skill set that is the key to our strengths may become a weakness.

Actuaries build models. These models are the tools to reduce the messy to the manageable, stripping complex reality down to something that can be understood and acted upon. And as we become familiar with these tools and good at working with them, we become attached to them. That attachment may leave us blind to a model’s limits. We may miss the instance where the model ceases to usefully describe reality, when something that has been left out becomes material.

The modeler’s skill is not just in building and running the model, but in understanding it, in knowing how far it can be taken and what it isn’t showing. As actuaries (and others) turn their existing models to analyze climate questions, that understanding will likely be tested.

Consider, for example, these two scenarios concerning the difference between analyses of the implications for investment portfolios:

1. A net-zero world in which global greenhouse gas (GHG) emissions are sharply reduced, leading to the achievement of the goal of the Paris Agreement to limit the increase in the global average temperature to well below 2°C above preindustrial levels.
2. A not-zero world in which emissions exceed the agreed-upon targets and the atmospheric blanket around the earth keeps getting thicker.

The net-zero scenario is primarily based on economic transition. The transition is enormous and wide-ranging (reaching well beyond the obvious areas such as the energy sector). Still, it seems quite possible that existing models and financial techniques could—with suitable adjustments—be usefully applied to such an analysis.

The not-zero scenario is a different story. It is a scenario that fundamentally disrupts everything. It implies extreme weather events, massive loss of biodiversity, rising sea levels, geopolitical upheaval and a long list of direct and indirect consequences that we can only partially begin to anticipate. These are not variables that usually need to be considered in investment forecasting models; environmental stability and the broader social context are generally taken for granted. So those models would not be sufficient for not-zero. They would omit the things that will matter most, missing the point.

The implications of climate change are enormously challenging to model. There are no truly verifiable historical data that can tell us the long-term effects of releasing 2 trillion tons of CO₂ into the atmosphere, pushing the atmospheric concentration from 280 parts per million to 420 parts per million over less than 200 years. It has been at least 800,000 years since that concentration has been anywhere close to where it is today.

So, we must rely on—to an uncomfortable extent—logical conjecture and be more willing to treat our modeling results cautiously. We must recognize where our models cease to apply and be willing to think more broadly when the task demands it. This, in my experience, doesn’t always come naturally.

Open to Learning

So, the actuarial profession has at least two key strengths that should serve us well as we respond to the many questions that are arising—and will continue to arise—as the implications of climate change, direct and indirect, find their way into every corner of the economy and every aspect of our lives. But we must also be careful, recognize our limits, stay humble and, now more than ever, stay open to continuing to learn.

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 © 2023 by the Society of Actuaries, Chicago, Illinois.