IFoA: Climate scenario models ‘far too benign’
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The economic models underpinning climate scenarios in financial services do not take account of ‘tipping points’ or effects like civil unrest and mass migration, a new report by the Institute and Faculty of Actuaries and the University of Exeter has found. It proposes an assessment of climate risk which would show significant economic damage above 2°C of warming.
The report published on Tuesday found that “some current scenarios could have limited use as they do not adequately communicate the level of risk we are likely to face if we fail to decarbonise quickly enough”, according to IFoA.
Techniques being used now exclude many of the most severe impacts of climate change, it argues, such as sea level rise, heat stress or tipping points, whereby a change in the climate system becomes self-perpetuating. They also exclude second order impacts for society like civil unrest and involuntary mass migration.
To address the issue, the report recommends:
- Education on the assumptions underpinning the models and their limitations
- Development of realistic qualitative and quantitative climate scenarios
- Model development required to better capture risk drivers, uncertainties and impacts
The models currently used are “far too benign and, in some cases, implausible”, the IFoA says, which “severely limits the usefulness of the models to business leaders and policy makers, who may reasonably believe these models effectively capture risk levels, unaware that many of the most severe climate impacts have not been considered”.
The report also found a wide error margin in carbon budgets, meaning net zero carbon budgets could already be exhausted.
“Some economists have predicted relatively low economic damage – even from extreme levels of climate change. It is concerning to see these same economic models being used to underpin climate-change scenario analysis in financial services,” said Prof Tim Lenton from the University of Exeter.
Sandy Trust, lead author of the report and past chair of the IFoA Sustainability Board, said what is happening in the real world is largely excluded from current climate scenario models. Developing realistic downside scenarios that reflect the level of risk faced is crucial, he believes, saying this will decide how much effort is put into decarbonising.
“In the context of climate change, it is as if we are modelling the scenario of the Titanic hitting an iceberg but excluding from the impacts the possibility that the ship could sink,” he said.
Nigel Topping, UK climate action champion for COP26, said failing to include known non-linear effects in strategic thinking about climate change will lead to complacency, heightened risk and missed opportunities.
“The scenarios that are used as part of [Task Force on Climate-related Financial Disclosures] processes really matter – both because economic damage will grow much faster and because the transition to clean technologies will happen much faster than conventional economic modelling suggests.”
Those in governance positions have a fiduciary duty to understand and mitigate the risks posed to clients’ financial assets, argued Katie Blacklock, who is a non-executive director at Edmond de Rothschild, member of M&G’s with-profits advisory board and governor of the Health Foundation.
"To do so, we need to improve our collective climate literacy. Accepting the output of climate-scenario modelling at face value is at best inadequate and at worst dangerous – not just for the price of financial assets but for the planet,” Blacklock added.
Does your scheme actuary challenge the assumptions in climate scenario models?
