The climate scenario models in the financial services industry (FSI) significantly underestimate climate risk.

A new report from the Institute and Faculty of Actuaries (IFoA) created in partnership with the University of Exeter has found that the threat that climate change poses to our planet and society is not always reflected in the economic models that support climate scenario modeling in the financial services sector.

Titled, The Emperor’s New Climate Scenarios, the report calls for a need for urgent action to embed the impact of climate action into risk management. The authors point out several disconnects between the climate scientists, economists, those building models and model users in financial services.

Findings:
Some current scenarios could have limited use as they do not adequately communicate the level of risk if we fail to decarbonise quickly enough, the authors note in the report.

Current techniques exclude many of the most severe effects of climate change, like sea level rise, heat waves, and climate tipping points like the loss of Arctic sea ice or the Greenland ice sheet. They also exclude second-order effects on human society, like civil unrest and forced mass migration, which could have a big economic impact.

The report also highlights the uncertainty in carbon budgets, where there is a wide error margin, meaning there is a risk that ‘net zero’ carbon budgets may already be exhausted.

The report proposes a way forward to make a more realistic assessment of climate risk, which would show significant economic damage above 2°C of warming.

The way forward:
As well as providing detailed analysis of these challenges around climate scenario modelling, the report recommends ways to move forward:
1. Education on the assumptions underpinning the models and their limitations
2. Development of realistic qualitative and quantitative climate scenarios
3. Model development required to better capture risk drivers, uncertainties, and impacts

Author’s notes:
Professor Tim Lenton, from the University of Exeter, said, “We have identified a variety of positive tipping points in human societies that can propel rapid decarbonisation. We need the support of the capital and insurance markets to achieve this, and actuaries have an important contribution to make.”

Sandy Trust, Lead author and Past-Chair, IFoA Sustainability Board, said, “A fact still poorly understood in financial services is that there is considerable uncertainty in Earth system modelling, which has profound implications. Carbon budgets have high error margins and could now be negative for a temperature goal of 1.5°C. All of which reinforces the need to urgently reduce emissions by accelerating socio-economic tipping points, remove greenhouse gases from the atmosphere and repair broken parts of the climate system.”