Briefing: Current climate models cutting no ice with actuaries

By Jon Guy

Insurers have been warned that their risk models are failing to recognise the full impact of future climate change, with the current approach likened to that adopted by the owners of the Titanic.

A report from the Institute and Faculty of Actuaries (IFoA), created in partnership with the University of Exeter, has found that economic models underpinning climate scenario modelling in financial services do not always reflect the threat climate change poses to our planet and society.

According to the report, entitled The Emperor’s New Climate Scenarios – a warning for financial services, there is a clear disconnect between climate scientists, economists, those building models and model users in financial services.

It warned that some current scenarios could have limited use for planning as they do not adequately communicate the level of risk the country will likely face if the world fails to decarbonise quickly enough.

Worryingly, the report explains that modelling techniques being used now exclude many of the most severe impacts of climate change, such as sea-level rise, heat stress or climate tipping points, where a change in the climate system becomes self-perpetuating – such as the loss of Arctic sea ice or the Greenland ice sheet.

Most current models also exclude second order impacts for human society, such as civil unrest and involuntary mass migration, which could cause significant economic impacts.

Not doing the basics

Sandy Trust, lead author and past chair of the IFoA Sustainability Board, said the current models were missing the most basic of risk assumptions.

“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 explained.

“It is critical we develop realistic downside scenarios that reflect the level of risk we face.”

The key finding is that the omissions severely limit 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.

Professor Tim Lenton, from the University of Exeter, said: “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.

”It is essential that financial services institutions and regulators move towards realistic climate scenarios that recognise the potentially catastrophic risks posed by climate change.”

It has always been the case that insurers have viewed models as one of a number of tools in the underwriting process, but when it comes to climate there may now be a need to sharpen the axe.