How could actuarial professionals, tasked with risk management in the financial sector and beyond, have ignored the biggest risk humanity has ever faced?
It’s difficult to get one’s head around, but the simple fact is that actuaries have so far failed to even begin to factor into their financial models the impacts of climate change and resource scarcity, apart from a narrow focus in some insurance products related to direct weather impacts. This is despite the fact that the issues have been known about for years and the consequences could spell disaster for their companies, never mind the rest of society.
This failure, which could be construed as a dereliction of duty, has been rammed home by a new report, commissioned by more progressive forces within the Institute and Faculty of Actuaries, which shows that global warming and its associated challenges could wipe out the entire defined benefits pensions industry within 30 years if we don’t rapidly change course.
The Resource Constraints research report, published by the Global Sustainability Institute at Anglia Ruskin University, is blunt and worth quoting: “The more extreme scenarios modelled represent financial disaster; the assets of pension schemes will effectively be wiped out and pensions will be reduced to negligible levels.”
Let’s be clear what that means. Millions of people in the UK alone will lose their entire nest egg and will be forced to rely only on their basic state pension at a time when prices of basic staples such as food, energy and water are rocketing. There will be no bail out by the government because it won’t have the financial capacity to help on such a scale. And we think we have got problems now?
It is important to point out that the “more extreme” model talked about does not by any measure represent the worst-case scenario, but is based on business as usual, where governments and the financial markets remain focused on the short term, and global economic decline as a result of a scarcity of energy, food and water.
The report goes on to say: “Were the global economy to go into long-term decline, the legal basis on which financial products sit could conceivably be undermined, and the sponsor employer may no longer exist to pay contributions. The financial markets may also cease to exist, at least in their current form, and hence the projection would become meaningless.”
Given that key issues such as climate change and resource scarcity have been well understood for a number of years, with an increasing recognition that businesses and the financial markets need to go through a fundamental change, how have the actuaries responded?
The report does not pull any punches: “Currently, actuarial models are effectively discounting to zero the probability of economic growth being limited by resource constraints. If resource constraints are significant, this means that current models will persistently understate the value of liabilities.”
While the financial markets are complex with many intermediaries, actuaries are particularly important in the chain of command as their job should effectively act as the canary in the mine. If they don’t warn of any dangers ahead, then everyone else can carry on with the belief the way ahead is clear.
I chaired a conference yesterday at the Institute and Faculty of Actuaries to debate the findings of the report. What was particularly interesting was the response I got when I asked the audience whether they felt they had the ability and authority to raise the alarm.
On the whole, they felt powerless to act; worried either that they did not understand the issues well enough or that the senior management of pension funds and insurers were so consumed with short-term gains, that they would be laughed out of court.
One actuary, pointing to the name of the report, said the main problem was that the financial markets did not believe in resource constraints and certainly did not want to share, whether it was a finite world or not.
Concerns about having the courage to shout out that the emperor has no clothes are repeated across the financial markets. The dominant narrative of short-termism is so powerful, partly because incentives are based around a short time horizon and that anyone who speaks up fears being ridiculed and ostracised.
That’s the bad news. But what positive signs are there for the actuarial profession to change course? Perhaps most important is that the institute and its thousands of members in the UK and abroad now have the research to interrogate, which hopefully makes it a little harder to ignore, and puts them at risk at being held culpable if they continue to sit on their hands.
The other positive is that there is an alliance of wise minds and young hearts seeking change. Enough senior actuaries are showing concern, which hopefully will influence their colleagues, and there is a small cohort of young professionals who recognise the need to change.
It’s important to understand the type of person who tends to become an actuary. They are essentially mathematical engineers who evaluate the probability of events and quantify the contingent outcomes. This doesn’t necessarily make them nerdy, but it certainly means they more readily engage their heads in the office than their hearts.
The point of climate change, ecosystem collapse and the rapid extinction of species is that they are not just data points but deeply emotional issues. The actuarial profession would do well to learn how to integrate this into their work, for that, perhaps, will help them to have the courage to step forward and become part of the solution rather than the problem.
They could do well to listen to Janez Potočnik, European commissioner for the environment, who recently told me he could not understand why people sought a distinction between being emotional and rational: “Emotions are rational,” he said.
In 2010, a study published by job search website, CareerCast, ranked actuary as the number one job in the US (Needleman 2010). The study used five key criteria: environment, income, employment outlook, physical demands and stress.
Perhaps the job of an actuary, hidden deep in the belly of pension funds and insurers, has become a little too cosy. Was this part of the reason why they largely failed to spot the financial collapse? Let’s hope they don’t repeat that mistake this time around.
Next week Guardian Sustainable Business will be publishing an article by Aled Jones, co-author of the Resource Constraints: Sharing a Finite World report, on the questions actuaries need to be asking
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