July 5, 2023

Emperor’s New Climate Scenarios – a warning for financial services

Scenario modelling is an important component of the actuarial risk-management toolkit. In the context of climate change, scenario modelling enables financial institutions and regulators to investigate the impact of different climate futures, which is important given the challenges we face.

The Institute and Faculty of Actuaries (IFoA) partnered with the University of Exeter to produce this paper demonstrating how a deeper understanding of climate change, including tipping points can improve financial services climate- scenario modelling.

In the paper they use actuarial principles to examine the limitations and assumptions in relation to climate-change scenario modelling practices in financial services, focusing on hot-house world scenarios of 3˚C or more of warming. It demonstrates how current techniques exclude many of the most severe impacts we can expect from climate change, such as tipping points and second order impacts – they simply do not exist in the models meaning the models understate the level of risk.

Key findings: