In this article, The Institute and Faculty of Actuaries (IFoA) and the University of Exeter discuss how to improve climate-scenario modelling in financial services using actuarial principles. Scenario modelling is an integral part of the actuarial risk-management toolkit. Still, the article highlights that many models don’t consider severe impacts such as tipping points and second-order effects, particularly in hot-house world scenarios of 3˚C or more warming.
The article cautions that carbon budgets may be smaller than anticipated, and risks may develop more quickly. It also warns that regulatory scenarios can lead to groupthink, with scenario analysis outcomes being taken too literally and out of context. The authors suggest that education is needed regarding the assumptions and limitations of the models and that realistic qualitative and quantitative climate scenarios are necessary. They also call for better model development to capture risk drivers, uncertainties, and impacts.
Read the article Emperor’s New Climate Scenarios – a warning for financial services