Climate-Related Risk

Key Developments During 2018

Physical Risk

  • In the WEF Global Risk Report 2018 failure of climate-change mitigation and adaptation is reported as the fourth highest risk in terms of impact and the fifth highest risk in terms of likelihood, having been rated more highly than previous years. It also considered extreme weather events to be the second highest risk in terms of impact and the highest in terms of likelihood. The prominence of environmental risk reflects the findings from recent research on environmental conditions, changes in legislation, changes in global investments and the potential economic impacts of low-carbon transition.
  • The Intergovernmental Panel on Climate Change (IPCC) met in South Korea, in October 2018, to consider the Special Report “Global Warming of 1.5ºC”. The report concludes that human activities are estimated to have caused approximately 1.0°C of global warming above pre-industrial levels and global warming is likely to reach 1.5°C between 2030 and 2052 if it continues to increase at the current rate. Climate-related risks for natural and human systems will depend on the magnitude and rate of warming, geographic location, levels of development and vulnerability, and on the choices and implementation of adaptation and mitigation options.
  • In its November 2018 Emissions Gap Report the UN reported that global emissions have reached historic levels with no signs of peaking and the current pace of national action against the Paris Agreement commitments is insufficient to meet the Paris targets. However, it highlights the momentum from the private sector and untapped potential from innovation and green-financing as pathways to bridge the emissions gap and reach the target of keeping global warming below 2°C. The report calls for increased action and innovative solutions: risk-acceptance, commercial scalability, holistic economic alignment, mission-oriented approaches and a long term-horizon to increase financial uptake.

Liability Risk

  • In its November 2017 snapshot of global trends in climate-change legislation and litigation, the LSE identified approximately 1,400 climate change-relevant laws worldwide, a twentyfold increase since 1997. It also found that the number of climate litigation cases has grown. Environmental lawyers, ClientEarth, have recently published two reports showing that the evidence on climate-related financial risk continues to grow.

Transitional Risk

  • Research published in Nature, using a simulation model to study the macroeconomic impact of stranded fossil fuel assets (SFFA), found that SFFA would occur as a result of an already ongoing technological trajectory, irrespective of whether or not new climate policies are adopted; the loss would be amplified if such policies were adopted; and the magnitude of the loss from SFFA may amount to a discounted global wealth loss of $1–4 trillion.
  • During 2018, a number of European insurers and banks committed to pulling back from investing in and insuring the most polluting industries under pressure from environmental groups and activist investors.
  • Royal Dutch Shell, the world’s second largest publicly traded oil company, recently announced major commitments to reduce its carbon footprint and to reduce greenhouse gas emissions 20% by 2035 and 50% by 2050. The company’s targets will include Scope 3 emissions (i.e. it will include direct and indirect emissions from consumers such as drivers who use their fuel). The company will also tie executive remuneration to achieving these commitments.

Climate Adaptation

  • As well as efforts to cut greenhouse gas emissions, 2018 has seen an increase in actions to adapt to climate change by boosting resilience to current and anticipated climatic hazards. For example, in October 2018, the Global Commission on Adaptation was launched (It will produce a report on innovative approaches to spreading and financing climate adaptation, to be presented at a UN summit in 2019) and in December 2018 the World Bank committed to invest $200 billion over five years to help developing countries invest in cutting emissions and boosting resilience.

Regulators’ Actions

  • The effects of climate change and the associated transition to a low carbon economy may have a major impact on financial markets and on products that serve those markets and is therefore of concern to regulators.
  • There have been several developments/publications in 2018:
  • The Task Force on Climate-related Financial Disclosures (TCFD) recommendations for forward‑looking climate-related financial disclosures have been widely welcomed. Numerous organisations, including the IFoA, are considering how they move forward with them. In March 2018, the Chair of the cross-party Environmental Audit Committee wrote to the top 25 UK pension funds to ask how they manage risks that climate change poses to pension savings and found that a quarter had committed to reporting in line with the recommendations.
  • Following the DWP consultation “Clarifying and strengthening trustees’ investment duties”, the Investment Regulations have been updated such that from 1st October 2019, trustees of occupational pension schemes will be required to set out, in their statement of investment principles (SIP), how they take account of financially material considerations and stewardship. The Regulations now make clear that the financially material considerations which trustees must consider when making their investment decisions include, but are not limited to, environmental, social and governance factors, including climate change.
  • In October 2018, the PRA issued a consultation paper on banks’ and insurers’ approaches to managing the financial risks from climate change. The purpose of these proposals is to set out how effective governance, risk management, scenario analysis and disclosures may be applied by firms to address the financial risks from climate change.
  • The FCA Discussion Paper “DP18/8: Climate change and green finance” sought input on four areas in which the FCA considers a greater regulatory focus is warranted: climate change and pensions – ensuring that those making investment decisions take account of risks including climate change; enabling competition and market growth for green finance; ensuring that disclosures in capital markets appropriately give adequate information to investors of the financial impacts of climate change; and the scope for the introduction of a new requirement for financial services firms to report publicly on how they manage climate risks.
  • In December 2018, DEFRA confirmed that the PRA, FCA, TPR and FRC will take part in the third round of adaptation reporting under the Climate Act 2008. Organisations are required to produce reports on the current and future predicted effects of climate change on their organisations and their proposals for adapting to climate change.

Actuarial Considerations

  • Actuaries in all areas should be aware of the physical, transitional and liability risks associated with climate-related risk including the actions being taken to mitigate and adapt to climate change. The IFoA has published guides to help and support actuaries working in the pensions sector to understand how climate change should be factored into their work. Similar guidance for the general and life insurance and investment sectors is currently being developed. Sources such as these provide information which actuaries and users may wish to consider when reviewing the impact of climate-related risk on their work.

Summary of 2017 Discussion and Actuarial Implications

  • Risks arising from climate change can impact all areas of actuarial work including methods and modelling, judgement, risk and uncertainty, communications, pricing and funding, reserving and capital modelling, investment portfolio design and management. For example, in life insurance and healthcare there is the risk of new epidemics or changes in mortality trends; in general insurance there is the challenge of modelling unpredictable and extreme weather events; in pensions there may be challenges in setting appropriate investment strategies. In all cases, including in wider actuarial fields, the lack of long-term data about the effects of climate-related risks may result in limitations in data, assumptions and models which need to be communicated clearly.
  • If actuaries fail to understand and make allowance for the impact of climate-related risk on existing work and practices or when moving into fields that are affected by climate change factors, then it could contribute to increased exposure within the financial system to these risks. This would not be in the public interest.
  • Actuaries may be able to advise on solutions where individuals or entities are no longer insurable due to excessive risk arising from climate-related claims e.g. by designing structures to pool risk or assessing the value of new risk management measures.
  • There is a risk of group think and systemic risk where actuaries collaborate to build new models to take account of climate-related events resulting in the widespread use of models which may be flawed. Actuaries could mitigate this risk by collaborating with other professionals, encouraging robust independent challenge and ongoing reviews.
  • Actuaries in all areas should be aware of the physical, transitional and liability risks associated with climate-related risk including the actions being taken to mitigate and adapt to climate change. They may be able to help decision makers to develop scenario analyses to assess their impact, inform strategy or consider these risks in governance, risk management and financial disclosures.

Further Reading

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