Sustainability implications for actuarial science

Yen Wong reviews the latest actuarial thinking on measuring economic, environmental and social sustainability.

In a recent paper presented at the ASTIN/AFIR/ERM/IACA Colloquia in Sydney in August 2015 and submitted for publication to the South African Actuarial Journal, titled “Environmental, Social and Economic Sustainability: Implications for Actuarial Science”, TL Reddy and RJ Thomson explore the shortcomings of current measures of sustainability which do not fully recognise environmental and social constraints to economic development. The economy is a subset of the environment as all renewable and non-renewable resource flows depend on it. Given actuarial work is underpinned by the use of the economic models and that actuaries take a longer term outlook, the authors stress the importance of factoring in environmental and social impact to provide better decision-making.

Triple bottom line

Since the environment is a finite global system, the authors propose that actuaries develop and apply the Triple Bottom Line (“TBL”) – an accounting framework with three parts: social, environmental and financial – to capture the social and environmental impacts over multiple time frames.  The authors believe that the need for better forward looking models for the actuarial profession means that actuaries are in a position to help develop and improve the TBL framework.

To measure an entity’s impact, the authors’ propose refining the TBL. While measures of financial profit are common but there is no systematic means of measuring social and environmental benefits. TBL seeks to capture not just the financial bottom line but the social and environmental impacts of the organisations activities, although not necessarily as an amount of money. Such a framework would allow organisations to optimise across all three bottom lines rather than solely focusing on the financial outcomes achieved.

This is the essential idea behind the Global Reporting Initiatives (GRI) – to encourage organisations to voluntarily produce TBL reports. The authors point to shortcoming of GRI – chiefly that outputs (e.g. effluent discharge) are measured and not the effects (e.g. impacts on biodiversity from effluent discharge).

Enhancing TBL

The authors propose an enhancement to TBL by measuring these effects and to extend the measurement time frame beyond the reporting period to future time points to take into account delayed effects of activities. This idea underpins the integrated reporting framework.

The authors also make a distinction between performance-based measures and outcomes-based measures, where the outcomes-based measure measures ultimate outcomes. Outcomes-based measures are important because they allow for comparability between entities and accountability.

Sustainability is a systems-level concept and is exceptionally difficult to apply at a single organisation level. TBL is an organisation led concept, and the two concepts need joining up, which can be difficult. For accounting purposes, the authors propose that each entity has a proportional share and responsibility to system sustainability. In relation to setting greenhouse gas emission target this concept has been called ‘setting science based targets’.

Longer term focus

The paper notes the growing concern on the short-term nature and focus by investors, where incentives are based on performance against short-term market-related benchmarks, where market value of portfolios are based on current prices, and where investment holding periods are declining. They note that long-term investing is needed and investors need to incorporate sustainability issues into investment decisions.

Environmental, Social and Governance Risk

The authors note the development of Principles for Responsible Investment and other investment initiatives, including Socially Responsible Investing, because of growing sustainability concerns. The paper also discusses trustees’ fiduciary responsibilities and how taking Environmental, Social and Governance (“ESG”) concerns into account when investing is consistent with a trustee’s duty of prudence because there is significant evidence linking the financial performance of companies is affected by their ESG performance.  

Contribution of actuaries

The authors are interested in broadening the actuarial profession’s interest in environmental and social sustainability beyond the area of climate change and resource constraint. To that end, the authors acknowledge the need to work with other disciplines to enable a fully integrated approach.

The modelling is only part of the solution to drive better decision making. They also propose formulation of plans to achieve minimum levels of sustainability and accountability as an efficient way of restoring the global system to environmental and social sustainability. This idea may have policy implications.  The authors propose that the sustainability of an entity can be calculated as the sum of the cumulative economic, environmental and social bottom lines at a specified time horizon.  The net zero contribution line would then separate sustainable and unsustainable entities. Under this measure an entity with a negative score would be regarded as unsustainable, and a potential regulator might require it to submit a plan to restore efficiency.

This proposal is at odds with basic economic theory which would suggest pricing the externality of environmental damage either through cap and trade schemes or direct taxes would be a more efficient way of ensuring the market is operating within environmental and social guardrails.

Better decision-making

Regardless of the methods used, some corporates are recognising the interconnectedness and dependencies between the environmental, social and economic systems.  Paul Polman at Unilever has said “Why would you invest in a company which is out of synch with the needs of society, that does not take its social compliance in its supply chain seriously, that does not think about the costs of externalities, or of its negative impacts on society?” Recent divestment from coal by groups such as Axa and the Norwegian sovereign wealth fund indicate that some investors are also recognising this.  Actuaries play an important role in these decisions and any move to better decision making model which factors in environmental and social sustainability is an important step forward.

We would like to thank TL Reddy and RJ Thomson for their comments on this article, and note that we have made changes to this article in response to their comments.

 

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