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The Actuary The magazine of the Institute & Faculty of Actuaries

How actuaries can help with problems of sustainability and the environment

Australia is taking a lead role in developing
market-based solutions to serious environ-
mental problems brought about by various
economic activities. So perhaps it is not surprising to see the members of the Institute of Actuaries of Australia becoming actively involved in this ‘new economics’.
The skill set of actuaries has a natural fit with problem-solving requirements in environmentally sustainable economics. Some of the relevant skills are:
– long-term forecasting and assessment of long-term risks;
– modelling of complex dynamic populations;
– pricing risk transfer; and
– estimating sufficient capital for long-term viability or sustainability.
This article will first discuss the developments of actuarial work in this area that are taking place right now in Australia. Then, some ideas for future areas of involvement will be presented.

Actuaries and environmental economics
Growing global awareness of human-induced environmental problems and the need to move toward environmentally sustainable economies is giving birth to a host of emerging markets and creative market mechanisms to achieve such goals. Perhaps the most high-profile contemporary mechanism is the carbon credit trading system designed to facilitate reduction of carbon dioxide emissions, the most prevalent greenhouse gas, and to internalise the costs of pollution by polluters.
We have also seen active markets develop for CFC (chlorofluorocarbon) credits to bring about an overall reduction in ozone depletion of the upper atmosphere. Australia is now considering introducing markets for ‘biodiversity credits’ and salinisation control credits and is just about to launch carbon credit futures trading on the Sydney Futures Exchange.
In his 2001 presidential address to the Institute of Actuaries of Australia (December 2000), Tony Coleman addressed several driving forces of change and risk and the associated opportunities for the actuarial profession and highlighted some of the work already being done in these fields. One of the driving forces he mentioned was sustainability and the environment.
Mr Coleman’s address touched on:
– the growing demand for services related to the new environmental credits trading systems;
– risk management for both buyers and sellers of these tools;
– environmental reporting; and
– maximising long-term returns by running a company on a sustainable basis.
During 2000, the Institute of Actuaries of Australia established several environmental committees to look at actuarial applications in these new fields. The main committees are as follows:
– Energy and Climate Change Practice Committee Recent activity includes a submission to the Australian Greenhouse Office discussing risk management of carbon credit trading systems, a research paper on asset/liability management for a carbon pool manager, attendance at various environmental markets seminars, and presentations of their findings at annual Institute meetings.
– Biodiversity/Natural Resource Evaluation Committee Members of this group recently helped a graduate student at Melbourne University complete a research paper on the evaluation of biodiversity, limited to the pharmaceutical value of a certain region of Australia, by using various actuarial techniques.
In addition, the Institute of Actuaries of Australia has established subgroups to study the application of actuarial techniques to the rapidly growing area of ‘ethical investments’. Some members have also attended meetings such as the United Nations Environment Program Financial Services Conference (Melbourne 2000), highlighting risks and opportunities for financial services companies related to the environment in terms of new products, risk transfer, and asset management.
Along the lines of ‘green’ financial services products, Hancock Natural Resources Group, a subsidiary of John Hancock Insurance Company, established a Sydney-based global forest carbon sequestration programme. In a company news release dated 19 June 2000, the head of this new programme stated that:
‘the green sector, in particular, is emerging as one of the most rapidly growing areas of investment in many regions of the world’.
The release also claimed that the new investment products provide a hedge to financial interests in traditional sectors and will help with risk management for companies producing greenhouse gas emissions.
A number of actuaries in Australia are employed in the energy markets, since these markets were deregulated four years ago. Some actuaries have growing responsibilities in advising companies on the financial impacts of global climate change policy and environmentally sustainable activities requirements. Examples of projects include development of corporate climate change strategy, assessment of emissions trading on energy markets, and commercial analysis of ‘Clean Development Mechanism’ projects.
In 2000, the Sydney Futures Exchange worked in conjunction with NSW State Forests to design a product range based on carbon sequestered in Kyoto-consistent (the international ‘greenhouse gas’ treaty) forests. These derivative products are about to be traded on the exchange, and Australian actuaries are assisting carbon pool managers (who hold the forest assets backing the futures) with risk management.
Clearly, these are areas of potential involvement for actuaries worldwide. They are not specific to local markets, giving actuaries a wonderful opportunity to collaborate internationally on critical global issues.

Other potential demands for actuarial skills
In late November, I a 2000ttended a conference of ‘biometricians’ in the south-eastern United States. While most of the attendees were in the business of ‘tree-chopping’ (employed by logging companies, paper producers, and university schools of forest resources), and I am a ‘tree-saver’, I was encouraged by recent developments in forest resources management by the forestry industry. For example, in the Pacific Northwest, consortiums of environmental advocacy non-profit groups, forestry corporations, and state and national regulators are now jointly designing forest management practice through a forest certification programme. This leads to more complicated and environmentally sensitive forest management procedures and to a rapidly increasing demand for sophisticated ecosystem modelling, projection, and risk management tools.
To give one simple example: the ‘actuarial-type’ assistance that the forestry company and university representatives mentioned repeatedly, once they discovered my actuarial background, was the urgent need for comprehensive tree mortality studies!
Historically, biometricians and forest managers have largely ignored tree mortality because there wasn’t much money to be made from dead trees. But growing ecological awareness and the emerging holistic approaches to forest management recognise dead trees (standing and downed) as extremely valuable. For example, (naturally) downed logs in riparian areas (close to streams) are important to local fish populations and, consequently, to the fishing industry. Snags, or standing dead trees, are important habitat to many forest creatures and so make a critical contribution to forest biodiversity and sustainability. Downed dead trees are important for soil quality, animal habitat, and carbon storage. This means that the forestry industry, fishing industry, non-profit environmental advocacy groups, and governmental bodies are now clamouring for reliable tree mortality studies. The biometricians indicated that the actuarial profession could be of great assistance here.
University research departments and research stations of the USDA Forest Service, among others, are actively engaged in the evaluation of natural resources and the environmental services provided by them (such as clean air, clean water, productive soil, pollinators, climate control, nutrient and water recycling, and carbon sequestration), long taken for granted by the markets. As an extension of this work, another potential area for actuarial applications is risk-based management of natural resources and asset/liability management of natural environmental assets against human infrastructure liabilities.
Actuaries have spent years developing tools for risk-based management of financial assets and liabilities. It seems these techniques could be applied to risk-based management of natural resources whose services are strained by a certain level of human activity. Such an approach can help resolve the conflict between those who think natural resource extraction has gone too far and those who think it can go further without affecting sustainability.
Many recent changes in financial services will bring about significant changes for the actuarial profession, and we seek new opportunities emerging from those changes. The necessary move of the global economy toward more sustainable economic activities is likely to bring further changes to financial markets and to corporate and societal risk management. We already see tremendous growth in the green investment market for reasons ranging from ethics to risk management to return enhancement.
This new economic view requires careful management of long-term assets and liabilities, as well as sophisticated modelling, valuation, and risk management tools. Actuarial skills are perfectly suited to these applications, and the experience in Australia is already showing us how these skills can be applied in practice.