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Cars stuck in flood waters in the Phoenix, Arizona area.
The report, Resilience to Extreme Weather, is scathing of business surveys and economic forecasts. Photograph: Michael Chow/AP
The report, Resilience to Extreme Weather, is scathing of business surveys and economic forecasts. Photograph: Michael Chow/AP

Financial systems must consider extreme weather, or risk condemning millions to die

This article is more than 9 years old

A new Royal Society report calls for changes to global financial accounting and regulation to ensure extreme weather risk is correctly accounted for

It’s extraordinary how the financial markets that pride themselves on their data analysis and forecasting have such a blind spot when it comes to the impacts of climate change.

I was reminded of this by a new report released today from the Royal Society, which calls on our global financial systems to start considering the risks posed by extreme weather, or risk condemning millions of people to die.

The failure of financial institutions to focus on the dangers comes despite increasing numbers of businesses and other organisations reporting that their operations are being hit by droughts and flooding.

In fact, the Royal Society points out that between 1980 and 2004 the total cost of extreme weather came to $1.4tn (£8.8bn), of which just one quarter was insured. By the middle of the century, it is estimated that large coastal cities alone could face combined annual losses of $1tn (£6.3bn) as a result of flooding.

The report, Resilience to Extreme Weather, is scathing of business surveys, economic forecasts and country briefings that guide investment decisions and credit ratings, but that focus only on established risks such as the availability of skilled labour, access to export markets, political and economic stability, and financial incentives.

It calls for changes to global financial accounting and regulation to ensure extreme weather risk is correctly accounted for and comes up with suggestions for how to do this. Using the experience gained in the reinsurance industry, it calls on public and private institutions to undergo stress tests, which would include reporting their maximum probable annual losses due to extreme events, against their current assets and operations.

By bringing this information into the public domain and placing a value on resilience, the Royal Society hopes it will incentivise capital owners, ranging from homeowners and multinational corporations to cities and countries, to respond to the dangers.

The report concludes:

Until these risks are accurately evaluated and reported, companies will have limited incentives to reduce them, and valuations and investment decisions will continue to be poorly informed.

Although some disaster risk information is already disclosed and used by investors, the data and procedures for making assessments are not standardised, which can limit their usefulness. Ultimately, without financial reform, people’s resilience will be undermined in the future.

At the recent climate talks in New York, the UNISDR, part of the UN Secretariat tasked with ensuring disaster risk reduction, convened a coalition of accounting organisations, asset managers, central banks, credit ratings agencies, risk modellers, financial regulators and science leaders in an attempt to create what it calls resilience accounting.

The Royal Society believes a common set of measures and indicators could be relatively easily achieved within the next five years, at a very low cost relative to the costs inflicted by extreme weather.

Rowan Douglas, a member of the report’s working group and chair of the Willis Research Network, said:

If two otherwise identical international companies have different resilience to extreme weather risks, then one should have a proportionately lower share price or valuation to reflect this higher financial risk.

As the frequency and severity of extreme events is increasing, there is increasing exposure of assets to risk. This brings an ever larger disconnect between material risk and asset valuation. Unless financial reforms are made to correct this, we will condemn ourselves to building vulnerable cities in the coming decades at the cost of millions of lost lives and livelihoods and billions of lost dollars, often across regions and communities that can least afford these catastrophic setbacks.

The fact that the financial markets have until now put their collective heads in the sand should come as no surprise. Actuarial professionals, whose very job it is to look after risk management in the financial sector and beyond, have continued to ignore climate change.

I reported on this failure last year when the Institute and Faculty of Actuaries produced a report which showed that global warming and its associated challenges could wipe out the entire defined benefits pensions industry within 30 years if we don’t rapidly change course.

The Resource Constraints research report, published by the Global Sustainability Institute at Anglia Ruskin University, concluded:

The more extreme scenarios modelled represent financial disaster; the assets of pension schemes will effectively be wiped out and pensions will be reduced to negligible levels.

Currently, actuarial models are effectively discounting to zero the probability of economic growth being limited by resource constraints. If resource constraints are significant, this means that current models will persistently understate the value of liabilities.

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