Pension policymakers should consider the risk of climate “ruin” in their assessments and move away from viewing climate impacts as “tail risks”, a report from the Institute and Faculty of Actuaries (IFoA) has warned.
The Climate Scorpion – The Sting is in the Tail report said an “overshoot” of the 1.5C temperature threshold by 2030 is “increasingly likely” and should not be considered as a “tail risk” – that is the risk of an unlikely event occurring.
Any warming above the 1.5C threshold increases the risk of “multiple climate tipping points” whether that be “halting of major ocean current circulation”, Antarctic ice sheet collapse, or destruction of the Amazon rainforest.
The IFoA’s report said that “as a matter of urgency”, realistic risk assessments of climate change should be carried out that take into account “the full range of outcomes”, with financial services firms urged to reconsider their carbon budgets and net zero approaches.
Policymakers and the public should also be educated on “realistic climate risk assessment” and “positive tipping points”, including through the energy transition and rapid roll out of low carbon technologies.
It also called for a “planetary solvency framework” which would “combine nature, climate and societal risk assessments”, viewing nature as an “asset that provides ecosystem services to society”.
Financial services firms should therefore develop “appropriate governance structures” and rethink their net zero budgets which “may not deliver a 1.5C temperature goal”.
The report said: “To deliver this, financial services’ net zero methodologies may move away from financed emissions to a more holistic approach focused on corporate activity, transition plans and engagement. A key principle will be to support real world rather than paper decarbonisation.”
“Macro-stewardship”, or supporting long-term policymaking on the energy transition, can also be a key role of financial services firms, the report added.
The report also noted that the past several months have been “the warmest on record globally, by large margins”, with several climate impacts including extreme weather events “progressing faster than expected”.
It also said there is a 20 per cent chance of global warming reaching 4.5C if greenhouse gas emissions are doubled from pre-industrial levels (known as equilibrium climate sensitivity) – pointing out this is a higher chance of failure than in a game of Russian Roulette.
In addition, the “uncertain business” of carbon modelling means carbon budgets are “probabilistic” and may be based on, for example, a 50 per cent or 66 per cent chance of success, the report said.
“We would be extremely unlikely to trust our pensions or savings to an insurer with a 50 per cent 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,” it stated.
The report also examined the specific risks driven forward by climate change, including via emerging infectious diseases, food and water insecurity, and extreme heat stress.
It comes after the IFoA’s report last year which warned climate scenario models were “significantly underestimating risk”.
Lead author and IFoA council member, Sandy Trust, said policymakers need “realistic assessments of climate risk” if they are to be supported with “decisive” action to “accelerate the energy transition”.
She said: “As actuaries, we have a responsibility to play an active role in addressing the sustainability challenge. Our long-term thinking, financial system understanding, risk management mindset and probabilistic reasoning combine powerfully to complement climate science and communicate risks clearly to regulators and policymakers.”
University of Exeter climate change and earth system science chair professor Tim Lenton added: “This report puts forward the case for why and how the actuarial approach can be used for climate change. It compellingly argues that we should view climate risk as a problem of ‘Planetary Solvency’, understanding and managing risks to the long-term survival of global society.
“In short, we need to have a best guess about the worst-case and make policy on that basis.”
A version of this article originally appeared at Professional Pensions.