Risks of Linear Climate Assumptions

The report "Recalibrating Climate Risk: Aligning Damage Functions with Scientific Understanding" argues that current economic models significantly underestimate the unknown of future climate impacts. The document focuses on the profound uncertainty inherent in "damage functions"—the mathematical tools used to predict how global warming will affect GDP—and highlights a dangerous disconnect between economic theory and scientific reality. The report emphasizes that the future will be defined by "extremes," not the "averages" currently used in most models. There is significant uncertainty regarding the frequency and intensity of "tail risks"—low-probability but catastrophic events like massive storms or heatwaves. Unlike steady economic growth, climate damage is expected to be "non-linear," meaning small increases in temperature could lead to sudden, disproportionate economic collapses that current models fail to predict. A major wildcard is the potential for "planetary tipping points" (e.g., the melting of permafrost), which introduce "bounded collapse probabilities" that are currently omitted from standard risk assessments. Future uncertainty is exacerbated by how damages interact across different sectors and geographies. Damages are described as "cascading and long-lasting," where a failure in one sector (like agriculture) can trigger unpredictable "capital destruction" and "labour productivity losses" across the entire economy. There is deep uncertainty about how damage "compounds across time, space, and sectors," making it difficult for financial regulators to assess the true level of systemic risk. The report identifies "direct and indirect" failures in how climate risk is currently quantified. Much of the current future uncertainty stems from "arbitrary" functional forms and hidden assumptions in Integrated Assessment Models. While incorporating "expert knowledge" can help, the report notes that these judgments may be "biased" and that there is a lack of "expert confidence" when dealing with higher temperature levels. There is a "fundamental disconnect" between climate science and the "top-down macroeconomic perspective" used by financial regulators and investors, creating a "blind spot" for future climate-driven financial crises. The report suggests that the "greatest unknown" is the point at which climate damage exceeds the system's ability to adapt. To navigate this, researchers and regulators must move beyond "aggregate functions" and embrace "process-based approaches" that explicitly quantify the massive uncertainties of a warming world.

🌍 Climate risk is becoming non‑linear — and portfolios need to reflect that. ⛓️💥 In a recent paper J.P. Morgan argues that climate change risk is moving beyond gradual, linear trends toward tipping points: abrupt, self‑reinforcing and potentially irreversible shifts in the Earth system that are material yet under‑modelled in macroeconomics, financial stability analysis and asset pricing. 📉 They highlight examples such as weakening ocean circulation, ice‑sheet loss and ecosystem collapse, noting that these dynamics can lead to step changes in economic conditions, rather than incremental impacts, with implications for long‑duration assets, sovereign risk and regional stability. ✳️ Rather than refining probabilities, the paper advocates decision‑making under deep uncertainty, drawing on national‑security and disaster‑risk practice and emphasising resilience, buffers and optionality. For portfolio managers, this implies: ➡️ Distinguishing tipping points from traditional physical climate risk ➡️ Challenging assumptions of a stationary climate in long‑dated exposures ➡️ Identifying assets that perform under volatility and rising adaptation demand — not just transition winners 📢 The message is clear: we may not predict tipping points precisely, but investment frameworks should not implicitly assume they cannot happen. #ClimateRisk #TippingPoints #Resilience #InvestmentRisk #SustainableFinance

👉 Are we using the wrong tools to assess climate risk? A new expert-led assessment, drawing on the judgment of 60+ climate scientists, says that #climatechange introduces forms of risk that exceed the design assumptions of existing economic and financial frameworks. Here’s what that means in practice ⬇️ 🔹 Climate damages are structural, they reshape economies: where people live, what can be produced, how infrastructure functions, and which regions remain viable. 🔹 Extremes drive real-world risk: what actually destabilises societies and markets are heatwaves, floods, droughts, grid failures, food shocks. It’s the tails of the distribution that matter. 🔹 GDP misses mortality, inequality, displacement, ecosystem loss, and can even rise after disasters due to reconstruction. This creates a dangerous illusion of resilience. 🔹 Repeated shocks erode recovery capacity and propagate across supply chains, finance, migration, and geopolitics. 🔹 Beyond ~2°C, uncertainty widens sharply. Confidence in precise damage estimates falls even as consequences grow. 🔹 Tipping points expose the limits of economic modelling: At higher warming levels, model outputs can appear precise while resting on assumptions that no longer hold. At the same time, many models also underestimate positive tipping points in clean energy and innovation. The goal is to build resilience under deep uncertainty. For treasuries, central banks, regulators, and long-horizon investors, this means recalibrating governance toward: ➡️ precaution ➡️ robustness ➡️ transparency Because avoiding irreversible outcomes is always cheaper than trying to price them after the fact. read the report "Recalibrating Climate Risk" here 👇 https://lnkd.in/dx8wmRZ4 Green Futures Solutions (University of Exeter) Carbon Tracker @aurora trust

Superb report published today from Green Futures Solutions (University of Exeter) on the inadequacy of current corporate and financial risk models in accommodating climate risks. At its most fundamental, I see the failure of these risk models as the core assumption that our systems of the future - whilst dynamic - will retain the same basic structures, functions and features as they do today. The assumption that our social, economic, and environmental reality will march onward into a flat, linear, tabula rasa which extends infinitely into the future. Tipping points science shows us that this isn't true. With increased temperatures and continued ecosystem degradation, tipping points will be reached, and system collapses will follow. And with system collapses come cascade failures, and often unforeseeable (and catastrophic) consequences. These consequences and radical uncertainties have to be - as far as they can be - factored into a new generation of risk governance approaches, fit for the future that lies before us. In the Ecologi | B Corp™ team, we're spending a lot of time thinking about risk management strategies as a core component of - and motivator for - corporate climate action. On our project assessments, we use sensitive risk models which take into account extreme climate scenarios and the significant uncertainty that comes with them - so that we can bake-in precaution, prevention and resilience from the start. Risk assessment and management has become a huge part of the work we do, both internally and for our clients. It's not lip service to say that climate risk management is business critical. Climate change impacts are arguably the most foundational, most all-encompassing of all risk factors affecting businesses today. And many current risk approaches in use by businesses and investors just aren't up to the task. Read the report 👉 https://lnkd.in/evipkQNX Good write-up in The Guardian 👉 https://lnkd.in/eXPeYjt5 📸 : John Towner via Unsplash

Important new study in 'Nature' showing that extreme climate impacts are possible even at 2°C of warming. Current risk assessments often focus on “most likely” average outcomes, but this can give a misleading sense of security. Looking beyond averages, the study finds that even at 2°C, plausible outcomes for extreme rainfall in populated areas, drought in key agricultural regions, and wildfire-conducive conditions in forests can exceed the average projections associated with 3–4°C warming. In other words, also at 2°C there is a meaningful probability of extreme outcomes, as climate risk is not linear and not well captured by averages alone. 👉 In many domains, businesses routinely plan against plausible worst-case scenarios. Time to also do exactly that for climate risk...

The Probability Gap: How the mispricing of Climate Tail Risk threatens financial stability The financial sector relies on a simple yet increasingly risky misunderstanding of risk. We have traditionally regarded catastrophic climate scenarios as tail risks—unlikely events that are only a small part of our models. But what if the mathematical foundation for that perspective is flawed? This isn't a philosophical question; it's a measurable problem of model risk that needs urgent attention from any fiduciary responsible for protecting capital. After thirty years of developing enterprise risk management systems, from founding Algorithmics to creating RiskThinking.AI, I’ve learned that the biggest vulnerabilities come from assumptions we refuse to question. The evidence now shows that our core assumption about the likelihood of climate-related disaster is flawed, and it's time to revisit our understanding of risk from the ground up. The Probability Gap: Where Financial Models Diverge from Reality The gap between climate science and financial practice is evident. Recent analysis from Oxford Economics estimates a 57.5% chance of climate catastrophe scenarios. However, the standard Expected Credit Loss (ECL) models used by banks assign only a 5% likelihood to these same scenarios. This isn't a calibration mistake; it's a fundamental mismatch of scale that risks undermining systemic stability. Climate science indicates a 57.5% chance of catastrophic scenarios, yet traditional bank credit models assign them only a 5% weight. This isn't a calibration error; it's a fundamental "Probability Gap" at the heart of our financial system. We are misjudging highly probable outcomes as unlikely tail risks because our models—intended for a stable world of mean reversion—are not functioning correctly in our new, non-stationary climate reality. The result is a widespread mispricing of risk. When the data suggests that catastrophic outcomes are this probable, failing to consider them properly isn't just poor strategy—it is a breach of fiduciary duty. The only logical response is to update our framework. This requires a new technological infrastructure capable of modelling these complex, multifactor risks stochastically. After decades of building risk systems, from Algorithmics to RiskThinking.AI, I can say with certainty that the tools to do this exist today. The challenge is no longer technical; it's about leadership. Institutions that revise their planning assumptions and acknowledge the real likelihood of these tail events will gain a crucial analytical edge in the coming decades. Is your risk framework designed for the world that is, or the world that was? #ClimateRisk #FinancialRisk #RiskManagement #ESG #Finance #Adaptation #SystemicRisk #Leadership  

𝗜𝗻𝘁𝗲𝗴𝗿𝗮𝘁𝗶𝗻𝗴 𝗖𝗹𝗶𝗺𝗮𝘁𝗲 𝗖𝗵𝗮𝗻𝗴𝗲 𝗥𝗶𝘀𝗸𝘀 𝗶𝗻𝘁𝗼 𝗜𝗻𝗳𝗿𝗮𝘀𝘁𝗿𝘂𝗰𝘁𝘂𝗿𝗲 𝗗𝗲𝘀𝗶𝗴𝗻 𝗮𝗻𝗱 𝗠𝗮𝗶𝗻𝘁𝗲𝗻𝗮𝗻𝗰𝗲 Climate change increases not only the likelihood of hazards such as floods and storms but also their intensity and spatial reach. Since most infrastructure projects are designed for lifespans of up to a hundred years, it is essential to integrate climate risks into both design and maintenance planning. Traditionally, engineers have relied on historical data to estimate future risks. For example, the likely 100-year flood was calculated from past records, assuming that natural patterns remain constant. The core assumption behind this approach was that the future would behave like the past. This assumption held true until the late 20th century, when climate change began to invalidate it. The climate is now shifting too rapidly for the past to serve as a reliable guide. Therefore, climate change must be considered when estimating design parameters such as flood magnitude or peak discharge. For instance, the design flow for a dam spillway or the capacity of stormwater drains should account for future climate projections. Ignoring these changes can result in under-designed structures that fail under new conditions. As flood intensity increases, so does its spatial extent. Higher floods affect broader areas, expanding floodplains and putting new zones at risk. This expansion raises the cost of infrastructure development since higher safety factors or stronger materials are now required. Governments and institutions must allocate larger budgets for both constructing new infrastructure and maintaining existing ones. Existing infrastructure faces similar challenges. Structures built decades ago are now exposed to higher stresses than they were designed for, which increases the risk of deterioration and failure. This not only raises maintenance costs but also threatens human lives and economic stability. The dam break in Libya in 2023 is a tragic example. Beyond flooding, climate change alters river flows, reduces water availability, and increases the duration of dry seasons, affecting irrigation systems and hydropower generation. Urban drainage networks can be overwhelmed by intense storms, while rising temperatures reduce road lifespan and raise energy demand for cooling facilities. To conclude, it is now clear that the future will not resemble the past. Relying solely on historical data for infrastructure design is no longer practical. Engineers and policymakers must integrate climate projections into every stage of the infrastructure lifecycle. Doing so not only prevents failures but also protects public finances and ensures the sustainability of investments. Building climate-resilient infrastructure is therefore not only a technical requirement but also an economic necessity. The cost of inaction will always exceed the cost of preparedness.

Companies are facing a new reality. Climate hazards are no longer distant risks. They are hitting balance sheets, disrupting supply chains, and eroding profitability. Fixed asset losses could reach $610 billion per year by 2035, climbing to over a trillion by 2055. Extreme heat alone will drive nearly three-quarters of those losses, hitting telecommunications, utilities, and energy infrastructure hardest. Business as usual is no longer an option. Business on the Edge: Building Industry Resilience to Climate Hazards, published by the World Economic Forum (WEF) in collaboration with Accenture, examines the scale of these risks and what they mean for corporate decision-making. The report connects climate science with financial exposure, analysing how extreme weather, ecosystem collapse, and tipping points will reshape industries and economies. The global economy is built on assumptions that are no longer valid. Earth’s life-support systems are destabilising. Five critical tipping points may already be breached, triggering irreversible shifts. The Greenland and West Antarctic ice sheets are collapsing. Warm-water coral reefs are dying. Permafrost is thawing, releasing carbon and methane that will accelerate warming. Ocean circulation patterns are weakening, threatening food and water security across continents. These changes do not move in a linear fashion. They amplify one another in complex and unpredictable ways. Economic models are failing to capture the full extent of the risk. Financial losses from climate hazards are often viewed as isolated incidents, but they are compounding into systemic disruptions. Extreme weather events are becoming harder to insure. Supply chains are fracturing. Market volatility is increasing. The cost of inaction is rising faster than most business leaders realise. Some companies are taking steps to adapt. The ones that move now will be best placed to navigate the coming turbulence. Climate risk audits, data-driven scenario planning, and investment in resilience are no longer optional. They are fundamental to financial stability. The return on investment is clear. Businesses that integrate adaptation measures see returns between two and nineteen times their initial investment. This is a moment of reckoning. The rules of the game are shifting. Those who fail to see it will find themselves left behind. Those who act will not only protect their assets but shape the future of their industries. #ClimateRisk #BusinessResilience #Sustainability #ClimateAdaptation #RiskManagement #CorporateStrategy

The IMF’s climate risk work repeatedly highlights how climate hazards and adaptation choices can transmit into financial sector outcomes over time, including insurers’ exposure to weather related disaster risks and the role of reinsurance in net claims dynamics. 𝐏𝐥𝐚𝐲𝐛𝐨𝐨𝐤 (𝐩𝐫𝐚𝐜𝐭𝐢𝐜𝐚𝐥 𝐚𝐜𝐭𝐢𝐨𝐧𝐬 𝐟𝐨𝐫 𝐂𝐄𝐎𝐬, 𝐂𝐅𝐎𝐬, 𝐂𝐑𝐎𝐬, 𝐂𝐂𝐎𝐬) ↳ 𝐑𝐞𝐛𝐮𝐢𝐥𝐝 𝐭𝐡𝐞 𝐭𝐢𝐦𝐞 𝐡𝐨𝐫𝐢𝐳𝐨𝐧: Move beyond 12-month pricing plus a historical cat view. Operationalize 5-10 year “repricing realism” assumptions by line and geography (how quickly can you actually reprice, exit, or re-underwrite). ↳ 𝐓𝐫𝐞𝐚𝐭 𝐦𝐨𝐝𝐞𝐥 𝐮𝐧𝐜𝐞𝐫𝐭𝐚𝐢𝐧𝐭𝐲 𝐚𝐬 𝐚 𝐩𝐫𝐢𝐜𝐞𝐝 𝐫𝐢𝐬𝐤 𝐟𝐚𝐜𝐭𝐨𝐫: Add explicit loadings or capital buffers for model drift, demand surge, litigation inflation, and correlated perils. Make it visible in portfolio steering, not buried in actuary notes. ↳ 𝐋𝐢𝐧𝐤 𝐎𝐑𝐒𝐀, 𝐫𝐞𝐢𝐧𝐬𝐮𝐫𝐚𝐧𝐜𝐞, 𝐚𝐧𝐝 𝐮𝐧𝐝𝐞𝐫𝐰𝐫𝐢𝐭𝐢𝐧𝐠 𝐚𝐩𝐩𝐞𝐭𝐢𝐭𝐞 𝐢𝐧 𝐨𝐧𝐞 𝐠𝐨𝐯𝐞𝐫𝐧𝐚𝐧𝐜𝐞 𝐥𝐨𝐨𝐩: If the ORSA scenario says volatility rises, the reinsurance tower, attachment points, reinstatements, and aggregate protections should show the same story, and underwriting authority should follow it. IAIS expectations make this integration harder to avoid. ↳ 𝐈𝐧𝐯𝐞𝐬𝐭 𝐢𝐧 𝐫𝐞𝐬𝐢𝐥𝐢𝐞𝐧𝐜𝐞 𝐮𝐧𝐝𝐞𝐫𝐰𝐫𝐢𝐭𝐢𝐧𝐠 𝐚𝐧𝐝 𝐫𝐢𝐬𝐤 𝐞𝐧𝐠𝐢𝐧𝐞𝐞𝐫𝐢𝐧𝐠 𝐚𝐬 𝐠𝐫𝐨𝐰𝐭𝐡 𝐬𝐭𝐫𝐚𝐭𝐞𝐠𝐲: Close the protection gap by underwriting mitigation, not just loss. Where physical risk is rising, resilience services and parametric structures can be the difference between staying in market versus withdrawing. Long-term climate and catastrophe modelling is no longer an “innovation project.” It is becoming a solvency, conduct, and competitiveness requirement, with global standard setters reinforcing supervisory focus on climate risk within core insurance governance and risk management. If your board asked today, “Which assumptions in our cat and climate framework are most likely to be wrong, and what is our plan when they are,” what would you point to first? #Reinsurance #ORSA #Catastrophe #Climate #Insurance — ♻ Repost to help others in your network. 💾 Save this post for future reference. ➕ Follow me ( Kirill Patyrykin ) for more

🔥 +7°C by 2200 — even if we control emissions? A new study from the PIK - Potsdam Institute for Climate Impact Research suggests just that. Using their CLIMBER-X model, researchers found that feedback loops in Earth’s carbon cycle could push warming more than twice beyond current projections — even under moderate emission scenarios. 🧠 What does this change? - Climate risk is nonlinear — 7°C isn’t just “twice as bad,” it’s potentially 10x worse - Crop collapse, famine, migration, and infrastructure loss become highly likely - Tipping points like permafrost melt and mega-fires are already accelerating - Paris goals aren’t just targets — they’re a narrow path through systemic chaos 📌 At SQUAKE, we track GHG because behind every gram is a deeper story: of stability, resilience, and future-proofing. Methodologies must reflect not just removals — but risk. Climate change is a feedback system, and so should be our response. #ClimateCrisis #CarbonAccounting #FeedbackLoops #NetZero #SQUAKE #ClimateModels #GHG #Sustainability #SystemsThinking #Permanence #Resilience #ClimateRisk #ParisAgreement