Finance as a response to environmental crises? Conference Day 3

The last day of the conference’s theme is insurances and their models.

Climate change becomes more and more apparent (not to say obvious) through increased natural disasters, tolling human and nonhuman animals’ lives. Financial markets have recognised the need to develop tools to better evaluate climate change and its impact on investments and insurance.

An interesting talk given by Ian Gray (UCLA) titled ‘Catastrophe Merchants: the convergence of risk analytics and climate data in the estimation of disaster loss’ investigates how models to assess insurance have changed and adapted since their conceptualisation in the 70s.

What is a catastrophe model?

Private sector companies performing valuation work at the interface of risk and extreme or difficult to calculate hazard events. The modellers generate data valuable for different actors: direct clients such as insurance companies, hedge funds, investors, brokers, large commercial companies with property, and also indirectly affected actors such as homeowners.

From the 1970s synthetic event histories were theorised, using probability distribution. But of course, these proved to be unreliable and so with the computational advancement, engineers in 1980s developed the first component: the event catalogue. The catalogue comprised a historic database (200 named events from 1900-2016) and for each event different parameters were generated, for example the speed of wind. The parameters were then populated and run simulations through the circuitry of the model. They could estimate how a storm maintains its integrity and match this with insurance portfolios that are then able to generate probabilistic loss. For example, what kind of damage can the wind cause to the type of house and type of geography in which the hurricane occurs.

The results are then presented in a tabular form that details things like:

1. an annual probability of occurrence
2. Loss and damage
3. Average annual loss: gives a number that helps to decide what the premium for insurance will be.

This model was hard to sell and after Hurricane Andrew in 1992, because historic modeling was based on pre-climate change where relative weather stability and consistency was possible to predict. Following increasing unpredictable and destructive weather, the insurance industry (8 insurers went bankrupt) had to reconfigure their modelling to premium pricing. Then another unprecedented two category 3 hurricanes in 2004 and 2005 hurricanes revealed once more that insurance models were underperforming which gave rise to the need to rethink how to model catastrophe estimates for insurance.

Jayme Walenta made an interesting comment that ties the financial with the social asking how does this catastrophe insurance modelling manifest for individuals on the ground? Another interesting issue to consider raised by Alice Valiergue regards social and economic inequality highlighted by the hurricanes in the US. While the rich had the means (cars, finances) to prepare for the hurricanes and evacuate early, the poor were forced to stay behind through the storms. Taking social inequality into consideration, how would then this influence insurance?

Next, Nick Taylor (Goldsmiths College, University of London) discusses his working paper on the way actuarials respond to environmental crises. If you are like me, you’re probably wondering what ‘actuarial’ means. (If you’re smarter than me, please feel free to jump ahead!) An actuary is a business sector that deals with measuring and managing risk. For example, if we take Ian’s paper above, actuaries working in the aftermath of Hurricane Katrina (2005) would need to estimate the long-term levels of the damage in order to assess property insurance.

Nick investigates professionals who work on the long-term future, challenging distinctions drawn between technical and ethical questions. Some of the questions he is interested in examining are:

• How do actuaries understand their ethical responsibilities as a profession?
• How are actuaries responding to environmental crisis?
• What competing understandings of risk and value exist in the actuarial universe? What hope is there for actuaries to effect a transition to a low carbon economy?

Why are actuaries important?

They claim professional expertise who have power in the investment chain as agents of capitalization constantly thinking about future revenues and how assets of liability match up. Ian is interested in seeing how actuaries thinking about modelling and financial economics as part of the solution to environmental sustainability.

Ian interviews actuaries across professions and finds a split between those who are environmentally conscious, actively trying to incorporate climate risk into their jobs, lobbying regulators, and other who do not take climate change into consideration at all.

Actuaries are having limited success to regulatory circles, and disclosures, although necessary, are contestable and insufficient. It is important to study this profession to investigate how this profession manages, or not, financial risks and how their statistical and financial tools are adept at resolving the urgent environmental crisis.

Next presenting a project on Sustainability’s Landnahme: economization, commodification and financialization in the Round Table on Responsible Soy, Juan Ignacio Staricco begins by setting the context for the “soy boom” currently experienced in South American countries such as Brazil and Argentina, where soy was an extremely marginal crop not a decade ago.

Soy is in fact much more targeted to corporations because the destination of most soy production is animal feed, which makes it an invisible product to consumers in terms of accreditation. Meat packaging does not display labels with information of fairly traded soy. There is a detachment between the commodity and the certification, unlike the well-known Fairtrade labelling. It is against this backdrop that a number of initiatives with the goal of securing more sustainable conditions of soy production and trade have begun to emerge.

Due to the change in traditional crop plantation, a large part of current soy plantation is directly linked to deforestation because now most soy plantations are in places where forests used to be. Governance initiatives like the Round Table on Responsible Soy (RTRS) are attempting to tackle problems like this through economization, commodification and financialization, trying to guarantee a zero deforestation in responsible soy production that also protects producers.

RTRS in a nutshell:

Founded in 2006 and with standards since 2010-2011. It is a multi-stakeholder initiative made up for three constituencies: producers+industry, trade and finance + civil society, designed in this way in order to regulate soy production with an environmental justification. RTRS creates a market for its exchange as a commodity. The combination of standards and the audit process and the final certification set the condition for responsible soy trading. A RTRS product distinguishes itself from other soy products by this ethical added-value. RTRS tries to be the political authority that regulates this market. However, RTRS is based on a voluntary basis, and does not have enforcement power, they cannot create a situation of scarcity to drive the market and so the main incentive for drawing in investors is diminished.

At the close of the conference, Anita Engels reminds us that must acknowledge that we haven’t discussed the macro international political relationships which are major players in the ways environmental conservation and protection evolves.

Going back to the question of actors and expert opinions, and the way we see ourselves as researchers, how can we change devices and bring research to be used as an activist tool, we can blog, bring our universities and institutions to divest or hybridizing between switching between carbon accounting, research, activism.

Finally, I would like to thank the organisers for allowing me to learn from the expertise and work of all who presented and shared ideas in this exciting conference.