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Financial Services Scenarios Underestimate Climate Risk

A new report published by the Institute and Faculty of Actuaries (IFoA) in collaboration with the University of Exeter has highlighted the urgent need for the financial services sector to effectively consider and integrate the impact of climate change into its risk management strategies. Titled ‘The Emperor’s New Climate Scenarios – a warning for financial services’, the report reveals a significant disconnect between climate scientists, economists, model builders, and users within the financial services industry. According to the findings, the economic models currently used to underpin climate scenario modelling by financial institutions often fail to adequately reflect the magnitude of the threat posed by climate change to our planet and society. Existing scenarios omit crucial factors such as sea level rise, heat stress, climate tipping points, civil unrest, and involuntary mass migration, all of which could have severe economic implications. “The results emerging from current models are far too optimistic and, in some cases, implausible,” the report noted, employing actuarial techniques to examine the limitations and assumptions of the models. This misrepresentation of risk levels severely limits the value of the models for business leaders and policymakers who rely on them to inform decision-making processes. Professor Tim Lenton 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.”

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