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The Actuary The magazine of the Institute & Faculty of Actuaries

Environment: Going green

Members of the Institute of Actuaries of Australia have been actively involved with climate change issues for many years, through their work with general insurers, public policy development work and in a variety of research and education activities. Climate change is just one of a variety of topics addressed by the Institute’s Energy and Environment Committee over the past ten years, but it has become a much more important and prominent focus in recent times.

It is widely accepted that dealing with the economic impact of climate change and the impact of our policy responses is a risk management issue for the whole planet. Actuaries may be more or less involved as individuals, but the profession clearly has an important role. The anticipated impacts of climate change include increases in storm damage, bushfires, flood and coastal inundation, as well as associated risks to human life and health. The related potential for financial losses warrants the attention of actuaries on the liabilities side of the balance sheet.

At the same time, the economic measures taken by governments in an attempt to mitigate the effects of climate change will have effects on the values of assets across the whole economy – perhaps nowhere more than in Australia, with its heavy reliance on fossil fuels and its high per capita emissions. All these costs will need to be borne, in addition to the potential direct losses of agricultural and other productivity associated with rising average temperatures, rainfall changes and rising sea levels – which are expected to be more severe in Australia than in many other countries.

If we have any interest in measuring the solvency, profitability or value of our major financial institutions, then we need to start assessing the scale of these impacts now. It is clear that they will materially affect the aggregate demand for capital in the near and medium term, change the nature of many Australian businesses, and materially modify the risks attaching to their equity and debt. No reliable understanding of the economy is possible without an understanding of the issues of climate change.

Fortunately, many elements of the actuarial skill-set can be applied to other environmental issues. The parameters are familiar – for example, there is usually a need for a long-term focus and data is uncertain. Often the development of solutions involves the understanding of the operation of market instruments. Management of risk is a major factor, particularly with issues like the potential impacts of loss of productivity, but also in areas like biodiversity and natural resilience. The principles of the actuarial control cycle have direct application to many of these situations.

In recent years, the development of a response to climate change in Australia was very slow and incomplete. However, since the change of government in November 2007 and the ratification of the Kyoto Protocol by the Rudd Government, there has been an acceleration in activity with commitments being made to reduce emissions in line with the rest of the developed world and to establish an Australian Emissions Trading Scheme (ETS) by 2010. A Mandatory Renewable Energy Target (20% by 2020) has also been introduced.

The forthcoming report of the Garnaut Review (an Australian equivalent to the UK’s Stern Review) has been preceded by some very effective interim reports that have significantly raised public consciousness of the issues and threats (and the potential upsides) and have strengthened the case to act decisively. At the same time, government departments are busy carrying out their own modelling. While government activity has been slow to develop, affected industries have been very active, particularly over the past five to six years. Actuaries have played an important role in this work. In addition, the Institute has been active in making submissions to government enquiries on many aspects of the policy response to climate change.

Members of the Institute working in the general insurance industry have been actively involved in researching the potential impacts of climate change on insurance costs, particularly in areas of storm and flood damage. Models have been developed that are able to quantify the cost and risk profile of significant increases in damages that could occur. This work is often sponsored by, and carried out jointly with Australian consultancies and/or insurance companies. The results of this research has been published widely in industry journals and presented at seminars conducted by the Institute and other organisations.

Recommendations have been made on how to provide more comprehensive flood insurance, including flood maps for Australia, public education and legislative facilitation. One insurer, IAG, has combined with a group of other companies to establish the Australian Business Roundtable on Climate Change. In 2006, this group commissioned research that highlighted the benefits of early action on climate change. IAG also is a sponsor of the Australian Climate Group in association with the WWF-Australia, a group of commercial and scientific experts that aims to promote effective public policy on climate change.

While we are not experts on many aspects of the practicalities of climate change policy, the Institute is in the position of being an independent observer with knowledge and expertise that is relevant to the development of economic policy responses to climate change. Part of the Institute’s mission is to promote the value of the actuarial profession, which includes contributing to and informing debate on public policy and business issues. Given the profound significance of the climate change issue to our long-term future and the applicability of actuarial skills to many aspects of the required response, the Institute has made several submissions to the current Garnaut Review and previous enquiries. The recent submissions concerning the proposed Australian ETS were designed to give an objective view of the merits of the Review’s ETS design proposals.

The Institute’s objective approach was seen to be particularly valuable because of the tendency of the public debate to be heavily influenced by commercial and political interests. The insurance submission was drafted in conjunction with the Institute’s General Insurance Practice Committee, and drew attention to the need for government action to facilitate an effective response by the insurance industry to the issues of particular importance in Australia: flood, coastal erosion, and bushfires. These are available on the Public Affairs section of the Institute’s website, together with earlier submissions and papers.

The Energy and Environment Committee of the Institute of Actuaries of Australia had its beginnings back in 1998. At that time there was an interest group called ‘The Committee on the Future’ that was examining long-term models of the future of the world. As it turned out, we were all concerned about environmental issues and wanted to investigate the methods being applied by governments and civil society. We thought that actuarial techniques might provide valuable additional insight into the analysis.

The Committee set out to write a paper for the Convention in Darwin in 1999, titled Natural Resources Valuation. This proved to be an ambitious project as we soon discovered how little we knew! We ended up providing an overview that would be available in any environmental economics textbook, plus some case studies on the techniques, as applied in practice. The case studies included measuring the carbon content of trees as they grow, fisheries management and the valuation of services provided by forests covering ecological functions, as well as timber production. A wide variety of activities have been undertaken over the past 10 years. These have included writing articles for the Actuary Australia magazine, presenting papers at the biennial conventions, drafting submissions to government inquiries, and working with university students, government departments and the Commonwealth Scientific and Industrial Research Organisation (CSIRO).

We have from time to time reviewed our purpose and role within the Institute, but the basic objectives remain:

>> To develop, promote and assist education of members in the energy and environment field
>> To undertake and assist in research projects and public debate regarding energy and environment issues, contributing a sound actuarial basis to the field.

From time to time the relevance of the Committee’s work has been questioned by some members of the profession who may consider the work to be too specialised or political. In view of the importance of the task, we have nonetheless pressed on. However, it is important to say that we have always tried to be professionally impartial and focus on the educational aspects of our role. The areas studied by the Committee can be divided in a few themes:

>> Valuation of forests and biodiversity
Immediately following the negotiation of the Kyoto Protocol in 1997, the Federal Government’s Australian Greenhouse Office released a series of discussion papers on the practical operation of emission trading. In 1999, the Committee drafted a submission to the Greenhouse Office discussing issues and solutions in relation to the risk management of forests acting as carbon sinks under the Protocol.

A group assisted an actuarial student doing a masters degree paper on the potential pharmaceutical value of biodiversity in a national park region using modified Capital Asset Pricing Model methodology.

>> Sustainability
The Committee has been monitoring the development of the socially responsible investment (SRI) market, now generally known as ‘Responsible’ or ‘ESG’ (Environmental, Social, Governance) investments. A group contributed to work on the analysis of the performance of socially responsible investments presented to an industry conference.

A paper was written for the 2003 Convention on corporate reporting of sustainability performance including case studies of actions being taken in the insurance and electricity industries.

>> Modelling techniques
We have reviewed techniques that would generally be described as futurist modelling techniques. We put this work into practice by undertaking Delphi study of the membership’s views of the future outcomes for a diverse range of social, economic and environmental topics. The results were described in a paper at the 2005 convention.

>> Climate change and energy issues
This area has become the major part of our work, much of it described above. We have had members working in the energy field who have written papers on fields as diverse as weather derivatives and how Australia can reduce emissions by 60% by 2050. Other members work for insurers, specifically on the development of responses to climate change and other sustainability issues.

Further Information
The Committee is very interested in the work being undertaken by the UK Institute’s Environment Research Group and we look forward to exploring opportunities for future collaboration. Further information about the work of the Energy & Environment Committee can be found at: http://www.actuaries.asn.au/AboutTheInstitute/EnergyandEnvironmentCommittee