Report: climate risk should be considered from an actuary perspective

April 10, 2024|Written by Moriah Costa

The rate of global warming and its impact on climate change is likely worse than initially thought, and a planetary solvency framework could help shape long-term policy decisions, a report from the University of Exeter and the Institute and Faculty of Actuaries has found.

“Climate risk impacts are increasing globally, the distribution is shifting and what used to be tail risks historically are now becoming more frequent. There are more stings and they are more painful,” the report says.

Actuaries are well positioned to consider risk from climate change, as evaluating risk is part of their role. Concepts like reverse stress testing, where actuaries think about circumstances that could cause insolvency, can easily be applied to climate issues, the report contends.

“The current way in which climate-change models and approaches are used would not consistently meet these standards,” the report says.

Climate change should be approached in the same way that actuaries approach financial solvency, by limiting the likelihood of a bad outcome as low as possible. For insurance companies, the probability of failure from not having enough capital to cover claims is 0.5%, which means they need to set aside enough capital for a 1-in-200 year event.

“Society as a whole might reasonably expect a similar standard for climate change and other risks that are faced,” the report states.

The authors analysed the latest climate research and found that climate change may be accelerating more than expected, which could have significant implications for financial institutions and insurance companies.

They found that there is an increasing likelihood of temperatures overshooting the 1.5ºC threshold and the climate may be even more sensitive than originally thought.

There’s also a lot of uncertainty with how much the world could warm in the future, given various factors, such as the ocean’s ability to absorb CO2, changes in nature, aerosol cooling, and the impact of clouds and melting ice.

Meanwhile, multiple climate tipping points could lead to systemic risks that could intersect and create cascading impacts like emerging diseases, food insecurity, water security risks and extreme heat stress.

All this uncertainty makes it difficult to calculate the carbon budget, or the amount of CO2 the world can produce before hitting the 1.5ºC threshold. In many cases, these carbon budget estimates give a 50% to 66%  chance of that temperature not being exceeded. That means the probability of failure – that temperatures will exceed 1.5ºC – is too high, the authors say.

“A 50% chance of success also means a 50% chance of failure. Likewise, a 66% or two-thirds chance of success means a third chance of failure, twice as high as the chances of losing Russian Roulette, a game few would choose to play, even for significant reward,” the report says.

“We would be extremely unlikely to trust our pensions or savings to an insurer with a 50% chance of ruin, yet by basing our actions on these carbon budgets we are accepting this level of risk or failure, when it comes to climate change.”

To approach climate change as an actuary, the researchers propose a planetary solvency framework to help guide policy decisions, as well as create a realistic risk assessment of climate change which takes into account the full range of possible outcomes, including worst-case scenarios and “risk of ruin”.

Countries should also educate the public and policymakers about these topics and risk assessments. A global and holistic approach to risk management of climate change can help reduce global temperatures, including rapidly reducing emissions to zero, removing greenhouse gases from the atmosphere, and repairing damaged climate systems.

A previous report from the same organisations published last July found that climate models used by financial institutions failed to accurately reflect the economic risks from rising global temperatures. A further report is planned that will expand on what a planetary solvency framework would look like.

This page was last updated April 10, 2024

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