Financial institutions are underestimating climate risks, actuaries warn

GDP damages could increase significantly as temperatures rise, with economic analysis pointing to a potential 50% fall later this century

Financial institutions are underestimating climate risks that could undermine the global financial system, finds a report published on Wednesday by the Institute and Faculty of Actuaries and the University of Exeter.

The report warns that mainstream risk models and economic forecasts have downplayed both the scale and the proximity of climate-related risks, increasing the likelihood of financial shocks that could emerge sooner — and prove more severe — than widely assumed.

“Global temperatures are accelerating faster than predicted, meaning current risk frameworks underestimate the frequency and severity of climate shocks,” said Jesse Abrams, an Earth system scientist at the University of Exeter and a co-author of the report, at a press briefing. “Governments and financial institutions need to revise their risk frameworks.”

Insured losses from natural catastrophes have nearly doubled over the past decade, according to data from Swiss Re cited in the report. In 2024, insured losses reached $145bn, up from about $77bn in 2015, adjusted to 2024 prices.

Swiss Re analysis shows that overall insurance losses from natural catastrophes are increasing at 5-7 per cent a year, a pace equivalent to losses doubling every 10 to 15 years. If this rate persists, average annual insured losses could reach $250bn by 2035.

The report authors say that this trend is “almost certain to continue and likely to accelerate”, with significant consequences for the insurance business model and for society more broadly. They warn that faster warming and increasing climate hazards may lead to rising claims, higher premiums and reduce the viability of insurance in high-risk areas.

Insurance plays a central role in economic activity by enabling households and businesses to take calculated risks. The report argues that sustained increases in losses risk weakening this function, with knock-on effects for investment, credit and financial stability.

Beyond insurance, the report points to larger macroeconomic risks. Its analysis shows that the potential for GDP loss increases sharply as temperatures rise, with global output potentially falling by around 50 per cent later this century under severe warming scenarios.

This is a scale of loss far greater than has typically been reflected in mainstream economic forecasts used by financial institutions and policymakers.

“We have underestimated the severity and proximity of these risks,” the report says.

Climate sensitivity may be higher than estimated

Based on recent scientific research and assessments from the UN’s Intergovernmental Panel on Climate Change, the authors conclude that climate impacts have arrived sooner than expected and have been more severe than expected.

One factor highlighted is evidence that the Earth’s sensitivity to greenhouse gases — known as climate sensitivity — may be higher than previously estimated, implying faster and more severe warming for a given level of emissions.

The report says that widely cited economic models suggest a 3C rise in temperatures would reduce global GDP by a relatively small 2.1 per cent, with a 6C rise cutting output by 7.9 per cent. It contrasts these figures with more recent analysis from the UK’s Climate Financial Risk Forum, which suggests it is plausible that a severe combined climate and nature shock could cause a 15-20 per cent contraction in global GDP over a five-year period.

This gap largely reflects the way mainstream economic models exclude many of the most material risks anticipated by scientists, the authors says. These include sea-level rise, ocean acidification, climate tipping points, nature degradation, impacts on human health, and the potential for conflict and migration.

A particular danger for risk management is reliance on outdated or overly conservative estimates, combined with over-reliance on model outputs without a full understanding of their assumptions and limitations, the report warns.

It argues that financial institutions and policymakers should adopt a “risk-risk assessment” approach — comparing the risks of action with the risks of unmitigated climate change — rather than relying on scenarios that implicitly assume a stable climate baseline.

Without such an approach, decision-making is likely to remain biased towards the status quo, understating the dangers of inaction and increasing the risk of systemic financial disruption, the report says.

“Climate change poses a systemic risk that could cause severe damage to investment portfolios if it continues to be mispriced,” said Faith Ward, chief responsible investment officer at Brunel Pension Partnership and chair of the Institutional Investors Group on Climate Change, who contributed to the study at the press briefing.