Claire Jones, Chair of the IFoA’s Resource and Environment Research and CPD Committee, reports on a recent sessional meeting.
A fortnight ago, Staple Inn was packed with actuaries and others who wanted to learn how actuaries can allow for climate-related risks when setting long-term financial assumptions. They heard from four IFoA working parties and an external speaker, before sharing their own thoughts through in-depth round table discussions.
Former IFoA president Colin Wilson opened the session by explaining actuaries’ professional duty to consider climate-related risks in their work, as highlighted in the IFoA risk alert last year. He then handed over to Nick Spencer, Andrew Claringbold and me to present our working party’s report on how DB pensions actuaries can allow for climate-related risks when setting long-term financial assumptions. This report is the last in a series of reports which support the Practical Guide for Pensions Actuaries we published last year (the other reports cover sponsor covenant assessments and mortality assumptions).
Nick made the case for actuaries to allow for climate-related risks by painting a compelling picture of how different our world might look in future and outlining the extensive regulatory interest in the topic. I explained that our working party had concluded that scenario analysis is currently the most practical tool available, given the uncertainties and difficulty in quantifying climate impacts. I encouraged actuaries to start with narrative scenarios and gave them some tips from our report on developing climate scenario analysis. Finally, Andrew presented a case study from Aon’s climate scenario work with pension scheme clients, describing the actions being considered as a result.
This was followed by short presentations from the chairs of three newer IFoA working parties that are developing Practical Guides to Climate Change for actuaries working in other areas. Patrick Race outlined how his investment group is using the actuarial control cycle as a framework and considering climate change under four headings: regulatory and scientific background; risks to be managed; strategic investment opportunities; and actions and considerations.
Next up, David Ford explained how the relevance of climate-related risks varies between life products, with long-term financial assumptions being most important for traditional savings and annuity products due to their longer duration and higher investment component. He noted that actuaries and firms should be progressing from general awareness of climate change to scenario testing, before moving onto more challenging topics such as the implications for strategic planning, solvency assessments, capital models and pricing.
Mark Rothwell then provided a general insurance perspective, highlighting the need to consider climate change implications beyond those of the short-term physical risks. He noted the relevance of transition risks and liability risks, as well as model risks arising from long-term and non-linear trends, reserving risks, and the strategic risks and opportunities for general insurers.
Finally, we heard from Vicki Bakhski of BMO Global Asset Management, who had led the development of The Institutional Investors Group on Climate Change (IIGCC)’s new report on Navigating climate scenario analysis: A guide for institutional investors. She provided valuable insights into leading edge work being done outside the actuarial profession on this topic, setting out a framework for action, practical examples and real-life case studies. She identified different approaches to climate scenarios (top down versus bottom up; physical versus transition risk; understanding financial risks versus measuring portfolio alignment with 2 degree scenarios), stressing the need to be clear about the objectives of the scenario exercise, understanding the assumptions underlying scenarios and translating high-level scenarios into investment-relevant variables. It struck me whilst listening to Vicki that actuaries have a lot to learn from other professionals, but also that actuaries have a lot to contribute by bringing a liability perspective to existing work on asset modelling.
We then moved into round table discussions, facilitated and scribed by members of the IFoA’s resource and environment community. Most participants had limited practical experience of allowing for climate change in their work and had come along to the event since they were keen to learn more. They identified a tension between the material financial risks posed by climate change and the difficulties in modelling them. One participant described climate change as “the most uncertain uncertainty” whilst another queried whether it was possible to isolate it from other risks. Some queried what weight climate change should be given relative to other major risks such as cyber, pandemics and artificial intelligence, whereas others stressed the importance of taking a holistic, systems thinking approach that could encompass interrelated risks.
There was general support for the scenario analysis approach, although also some appetite for progressing to stochastic asset-liability modelling of climate risks. Whilst some agreed that narrative scenarios are a practical first step, there was also strong support for developing quantitative modelling. The challenge is connecting climate pathways (the physical, policy and technology aspects) back to the financial system and the drivers of business, but this is also an opportunity for actuaries. As one person noted, “that’s what we do!” Although the speakers had emphasised how the future might differ from the past, two delegates pointed out that there may be useful lessons from the past, through developing our understanding of the drivers of historic investment returns and studying previous transitions such as the information technology revolution.
Lots of practical next steps were suggested which the working parties and research committee are now considering. There was strong demand for further IFoA work in this area, but also recognition that collaboration with external experts will be vital. We will be looking to help actuaries learn more about climate change, considering how to share best practice and discussing whether the IFoA should develop its own climate scenarios.
In the meantime, I encourage you to keep abreast of climate change developments by signing up to receive Resource and Environment news from the IFoA. You can do this by updating your contact preferences on the IFoA website.
If you would like to know more about the topics discussed, or contribute to future IFoA work on climate-related risks, please contact me or one of the other speakers.