Climate change – what can actuaries do?

Like a lot of firms, many of APR’s key strategic objectives are aimed at ensuring that our business is sustainable, and over the last couple of years we have been giving increasing focus to what that means and how we (better) achieve it.  Jack Miller’s report discusses our latest milestone in this ongoing process, the Basecamp accreditation we have recently received from Sustainable X.  The article below focuses on the climate aspect of the sustainability agenda and sits much more within the ‘Views’ category of our News & Views library.  It is a personal opinion piece written by Alan Reed, who has researched this area in depth with the aim of examining how APR, and indeed actuaries more broadly, may be able to have a more positive impact when it comes to climate change. Several of the examples used are from the UK, but the high-level points made are not UK-specific.

Public opinion, policy and research on this topic is evolving rapidly. We believe it is important for actuaries to be thinking about these topics, reading widely and listening to views from across a broad spectrum of sources.  Several of the points raised below question some of the activities of industries that actuaries work within. We do not expect all readers to agree with all of these points, but while they should not be considered to be the views of APR as a whole, we do very much embrace the idea that we all need to start thinking rather differently and addressing some perhaps uncomfortable truths. The article does not attempt to provide solutions to all of these complex issues, but it does aim to raise awareness of them and to highlight areas that you may not previously have considered as being relevant to climate change.  Some of the ideas Alan raises have really brought home to us the need to challenge the way we think about our business and what we can, and should, be doing differently. We hope that, like us, you find it to be an interesting and thought-provoking piece.

Tim Nash
Partner
October 2021

It is easy to become distracted from, overwhelmed by and even disengaged from activity around climate change, but there are lots of things we can each do as individuals in our personal and professional lives.  Anthropogenic climate change is a tragedy of the commons and requires each of us to think and act less selfishly than previously.  But responding to it isn’t about all of us putting on hairshirts and preventing ourselves from doing anything we previously thought was fun.  It is important for individuals to get into good habits on a range of things they can do which reduce their burden on the Earth, and to avoid getting trapped in inaction by thinking they have to take certain steps now that aren’t currently achievable for them.  My article below aims to highlight, and give a view on, some of the things we as actuaries might think about and do to help us each play our part in bringing about positive behavioural change.

Purpose and perception

Many actuaries are skilled at digesting detailed legal and regulatory documents. Get aware of regulatory change regarding climate change at a global, international and national level, not just where it impacts your professional practice.  Work from primary sources rather than from “messaged” content. Start with the Paris Agreement, the Met Office State of the UK Climate 2020 report and the IPCC AR6 Climate Change :  The Physical Basis report and work forward from there.

Actuaries are well used to assessing risk and reward for their employers and clients, often over the long term.  But our focus is usually only on financial risk and financial reward.  “Sweating” capital hard generally comes at someone else’s expense.  This may be via environmental pollution and degradation, over-extraction of resources, or exploitative working practices.  This is not sustainable.

Actuaries can play a role in developing business models for financial institutions which generate acceptable returns for investors while pivoting sharply towards benefits to society and the planet and away from negative impacts, whether this is termed “purpose-led”, “patient capital”, “natural capital” or a “circular business model”.  We can also play a role in developing and implementing means of measuring risk and return in not-only-financial terms and from the perspective of parties other than investors, creating means for the complex impacts of a project on all parties to be holistically captured.  But this is a crowded space.  For actuaries to progress in this space we will need to break down perceptions of actuaries as people who typically seek to maximise financial outcomes for financial institutions and institutional investors.

Investment aspects

Actively look at how your employer positions its products, services and its own impacts regarding climate and the environment.  Are they broad-based, balanced, objective and genuine, or are they narrow, oversimplified or biased?  Should an investment fund with “Carbon Transition Readiness” in its name be able to have large investments in oil, coal and firms closely linked to deforestation?  If your firm makes loans to commercial parties, do the terms require them to make holistic reductions in their adverse impacts that are greater than those which the territory they operate in needs to achieve in order to limit climate change to 1.5C, without just altering ownership labels on emissions so that more are blamed on their customers or suppliers?  If not then how are the terms of that loan not locking that firm in to retaining an unfair share of emissions?

Much of the financial attractiveness of large “green” projects to investors comes from commercial parties locking in to government-backed subsidy income and preferential permissions.  With many local UK public bodies highly -constrained in terms of human and financial resources, there is an incentive for commercial parties to closely align their interests with those of the public bodies that are supposed to be regulating them, and to obtain further financial advantage for their investors.  But every £1 of subsidy/grant captured by the project has to come from somewhere.  Much is funded from large levies on UK domestic energy bills, whose impacts are highly regressive.  Subsidy has a role to play in funding climate transition, including for large commercial projects, but £1 of over-capture of subsidy as profit for investors directly crowds out community and household investment.

The UK doesn’t just need large offshore wind farms, it also needs a large volume of household and community projects to mitigate emissions and adverse environmental impacts.  These are much less attractive to financial institutions than flagship industrial wind farm projects, but any institution that finds a way to genuinely facilitate and accelerate such bottom-up projects in a non-exploitative way will have found a genuine purpose and will enhance its reputation.  Could actuaries help find a way to integrate UK institutional investment funding alongside community-led and cooperative structures, generating acceptable returns for retail investors through pooling project risk and providing project management support?

Conflict of interest currently arises in actuaries’ work relating to real estate investment.  If we want carbon emissions to track downwards then we should perhaps avoid forcing people into an en-masse return into large offices if they can work effectively at home and are happy to do so.  Care is required to ensure that younger workers get opportunities to develop and that workers do not get isolated, but the prize of greatly reduced carbon emissions from commuting and unnecessary business travel is surely too important to be eroded away.  Such an outcome will lead to loss of value and stranding for some city centre commercial real estate, and some actuaries are among those with vested interests in retaining high valuations for such assets.  Where does the boundary lie between acting to boost short-term value for shareholders and policyholders/beneficiaries versus acting in the long-term climate and environmental interests of a wider population group?

Present value is key

Claiming an offsetting effect this year from planting a tree now, which will only capture significant amounts of carbon over 5-150 years (assuming it survives) is a blatant abuse of the concept of present value.  Can such offsets play a role – yes, but should they be confused with a direct contemporaneous offsetting action – not at all.  If the market for such offsets results in emitters being able to continue to emit more this year than they would have been able to otherwise, then climate change is accelerated.  Actuaries’ specialism in present value could shed light on such aspects.

Long-term discount rates are a topic close to much actuarial practice.  But how many of us have read Sam Gutterman’s 2020 Society of Actuaries paper on Social Discounting, and tried working out how such an approach, or alternatives, could improve decision making for effective investment in climate change response measures?

UK life industry’s readiness

Some of the business practices of UK life insurers in recent years can be seen as hindering the industry’s ability to respond to the climate change challenge.  Actuaries have played an active part in these activities.  Do we acknowledge this, and how might we reflect on it? For example:

• Over the past 15 years many UK life insurers have focused on delivering short-term targets for shareholder cash value extraction over and above more sustainable aims.
• UK life insurance groups have generated stock market value by splitting life insurers from asset managers and consolidating the life insurance portfolios into ever larger firms.  Such business models place a major commercial barrier between the life insurer as the beneficial owner of assets for its policyholders and the asset managers who are best-placed to aggregate information to allow the life insurer to genuinely understand the climate, carbon and environmental impacts of their asset portfolios.
• Many UK life insurers have built up large shareholder-owned illiquid long-dated private debt portfolios, sometimes with minimal climate/carbon/environmental consideration. Such portfolios are harder to evolve and more exposed to stranding risk than the bond portfolios that went before them.  Some of these illiquid portfolios are overweight in equity release mortgages, which keep older properties underoccupied for decades, create a direct disincentive for the energy efficiency of those properties to be upgraded, and leave younger generations who would be more inclined to improve those properties, if they could access them, living in cramped rental properties whose energy performance they don’t have the right to improve.  For more on this topic listen to this presentation given to the Society of Actuaries in Ireland.

Wider actuarial aspects

Actuaries with wider management influence in firms can work to reduce the end-to-end energy/carbon consumption relating to that firm’s activities. Using the GHG Protocol definition of Scope 1/2/3 emissions, headline Scope 1 & 2 emissions can often easily be reduced by outsourcing energy-intensive operations to third parties, but Scope 3 emissions are no less polluting than Scope 1 & 2.  If the firm controls its own offices then localized renewable energy that is used to displace existing grid-sourced consumption can have a positive impact (eg Aviva solar carports in Norwich and Perth).  If the firm has larger commercial real estate exposures, as landlord or as lender, then it should drive up energy efficiency and, where appropriate, localized renewables production.

There is a huge supply constraint on the availability of genuine quantum computing (as opposed to simulators of quantum computers). Using this to calculate annuity provisions that are 0.2% lower, and calculated more frequently, is not one of the top 1000 global problems that such technology should be allocated to.  Switching from an efficient algorithm run on conventional machines to a highly inefficient try-every-combination algorithm run on quantum machines would be particularly short-sighted.

Bitcoin’s carbon and waste footprint is huge and is credibly estimated to have doubled since April this year.  Private blockchain technologies may have potential within industries that actuaries work in, but the energy footprint of blockchain technologies should always be fully considered and accounted for.

Actuaries could bring complementary skills to emerging fields, such as supply chain verification and impact assessments but the field is complex.  For example, how can climate/sustainability-positive labelling of retail and wholesale products be ramped up to a level sufficient to generate large scale behavioural change at population levels, without creating structural weaknesses in the economy whereby fraudulent mis-labelling behaviour becomes the most financially profitable game in town?

The actuarial skillset outside the office

We should also reflect on what impacts individual actuaries have in our own personal lives.  Actuaries are, more often than not, substantially financially privileged compared to the median of their generational peers.  We are typically educationally advantaged with strong analytical and quantitative skills.  These are big advantages.  If we can’t find ways to add value for society in this area then why should we expect others to do so?

We can all write lists of things we think we could or should do to improve our impact on the climate/environment.  Doing some of these would be genuinely climate-beneficial, but not all.  The actuarial skillset can be effective in analysing possible activities, and distinguishing between those that may genuinely have positive impacts and those that are promoted as being green in order to generate economic activity or increase profit margins.

Uncertainty around fuels for future heating of homes is high.  But anyone who is lucky enough to own their own home can gradually renovate it to reduce its heat loss.  Where planning rules permit, installing solar panels at your home is relatively cheap and easy.  If you have savings and your own roof, then what is stopping you from getting quotes, checking them over and, if feasible, going ahead?

Heat pumps are a shinier “tech” solution.  Air-source heat pumps can be an ideal replacement for oil-fired heating for small/mid-sized homes in warmer parts of the UK.  Ground-source heat pumps are particularly complex to size and install as retrofits.  But if system design and installation is not top-notch then homes are left reliant on inefficient immersion heaters in the coldest weather, and can consume more energy (much of which is ultimately produced from oil/gas) than the system that was ripped out.  Installing a heat pump is not a substitute for improving home heat loss performance or turning the thermostat down a degree or two and wearing a thicker jumper.

Break out of the consumer bubble – don’t go out and buy a new electric vehicle just because you want to look green or feel you are being green.  A full EV is a great solution for a supermarket delivery van, with space for charging at its base, low maximum speeds and predictable bounded operating areas.  A full EV can be a good solution for high mileage city/suburban commuters in polluted areas, but reducing that commuting activity would be even better.  But for much domestic driving, currently, a self-charging mild hybrid is probably the greener option.  Estimates of the lifetime energy profile of EVs vary widely but all show that EVs consume much more energy at manufacture and only cross over to net-energy-positive after 60,000-100,000 km. Buying an EV and leaving it unused while you work from home is much worse for the planet than just keeping your old car.

But don’t just take these assertions at face value – do the research and run the numbers yourself.

Alan Reed

October 2021