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The Actuary The magazine of the Institute & Faculty of Actuaries

Sustainable development and the actuary

In September 2002, the United Nations held the World Summit on Sustainable Development (WSSD). The conference involved 21,000 delegates at the official meetings in Johannesburg. Its purpose was not to get politicians to agree to new initiatives, but to review the current obstacles to achieving sustainable development and to identify practical ways to address these problems.
Actuaries are already experiencing the effects of poor development practices. For example, insured losses from weather-related disasters have risen significantly in recent years. Insurers and reinsurers are having to allow for these trends in pricing and reserving, and are increasingly becoming involved in the debate on long-term environmental issues.
Lawrence Jackson is a member of the Institute’s Environmental Research Group working party

What is sustainable development?
Sustainable development is often poorly defined. Even the best proposed definitions are open to interpretation. One example, provided by Robert Solow, an economist at the Massachusetts Institute of Technology, is that sustainable development is ‘not to leave the world as we found it in detail, but rather to leave the option or the capacity to be as well off as we are’.
It may help to consider some cases of sustainable development. A good example is the Montreal Protocol (1987) on the manufacture of chlorofluorocarbons (CFCs). In the 1980s, the world awoke to the evidence of ozone layer depletion when a worryingly large hole was discovered over Antarctica. Implementation of the protocol was successful, with the manufacture of CFCs being almost totally eliminated. Today, evidence exists of repair to the ozone layer and we have a successful illustration of more sustainable business practices being demanded by politicians and adopted by industry.
What is unsustainable development? The current consumption of carbon-based fossil fuels in the world economy is becoming the overriding example of unsustainable economic behaviour. Burning carbon-based fuels such as coal, oil, and gas is increasing the emission of greenhouse gases, including carbon dioxide and sulphur dioxide. These environmental pollutants contribute to a greenhouse effect whereby the temperature of the earth is gradually increased. The United Nations Intergovernmental Panel on Climate Change has projected that, over the 21st century, global temperature will rise by at least 1.4?C and possibly as much as 5.8?C. Such changes in temperature will have a dramatic impact in many parts of the world.

Measuring sustainability
Without a clear measure of the quality of environmental behaviour, it is not possible to judge whether a particular activity is sustainable. Working with the World Economic Forum, Dan Esty of Yale University has developed an environmental sustainability index. Twenty-two key indicators of sustainability were identified. These indicators can then be weighted to provide an overall measure of sustainability for a country. The main difficulty with this index is determining the appropriate weights to place on each of the indicators. Countries have different national priorities, even aside from considerations of the appropriate balance between national and global environmental issues.
This is an area where actuaries could make a useful contribution. First, our skills may be valuable in converting the different indicators to a common currency, such as a monetary value calculated by discounting future cashflows allowing for the inherent uncertainty of future events. Alternatively, it could be another measure of health or well-being such as ‘years of life lost’. Measures based on life expectancy or years of life lost are familiar to most actuaries. Second, we could help to develop appropriate weights to combine the indicators into a single measure of sustainability. Our knowledge of statistics means we are able to interpret the individual measures in a scientific way and we are used to developing and interpreting measures of performance for companies.

Environmental consequences
Gross domestic product (GDP) rules supreme as the recognised measure of wealth and growth. From an environmental perspective this measure has many flaws. It takes no account of the use of non-renewable resources. A country that burns its coal resources may show economic growth in GDP terms as the energy is used to produce measurable goods. There is no allowance for the depletion of coal reserves, or for the long-term environmental cost associated with carbon-based fuels.
In 1993, the United Nations published guidelines for the production of national accounts that attempt to combine economic and environmental issues. This approach fell far short of a truly integrated system of national accounting with a single, environmentally adjusted measure of GDP. The difficulties are:
– Putting monetary values on environmental assets. What is the value of a panoramic view?
– Calculating the environmental cost of economic activity.
– Determining the value of remaining non-renewable resources.
These remain tricky questions today and could present interesting challenges to the curious actuary.
Actuaries could apply their skills in the valuation of future uncertain cashflows. Cost benefit analysis is a familiar tool. When assessing the economic and environmental impact of projects, projections often stretch many years into the future. Even if we are not experts on the factors underlying such projections, because they are based on specific industry or environmental knowledge, we are well placed to advise on assigning monetary values to alternative outcomes, and discounting projected cashflows to give present values or internal rates of return.
The choice of discount rate can be particularly difficult with environmental issues. For example, when considering decommissioning costs for a nuclear power plant, the choice of discount rates will have a significant impact on the present value of those future costs. The long time scales over which the cashflows emerge means present values will be extremely sensitive to discount rates. These issues are familiar to actuaries used to valuing long-term insurance business or occupational pension scheme liabilities.

A sustainable future?
Despite having been referred to as a ‘gabfest’ by The Economist, the WSSD saw some progress made. Important results were:
– A promise to cut the number of people with inadequate water and sanitation by 50% by 2015.
– Promises to protect fish stocks.
– Further countries (eg China) signed up to the Kyoto Protocol, which aims to reduce emissions of greenhouse gases.
– Establishment of partnerships between governments and companies to support development projects with private money and expertise.
In years to come actuaries branching out into wider fields could undoubtedly play a significant role in the move towards sustainable development.