Impacts of Climate Change on Financial Institutions’ Medium to Long Term Assets and Liabilities

Asset and liability management (ALM) is extremely important for the management of financial institutions. Institutional investors typically have medium to long-term liabilities (e.g. pensions are times for future retirement), and the duration and return of assets held will have to match these. This exercise typically involves the use of projection models and assumptions. Climate change (CC) has an impact on world climate today. This impact grows with the continual emission of greenhouse gas (GHG) in the atmosphere. The frequency and intensity of weather extremes may increase with CC, and this will affect most sectors of the economy. This report focuses on analyzing the impacts that CC may have on assets, liabilities and the ALM of financial institutions. CC will cause direct physical impacts which include worsened insurance claims to reinsurance, property, business interruptions, motor, ravel, directors’ liability, construction, agriculture and forestry, health and life insurances. In parallel, direct physical impacts will also be felt on asset investments, such as property, agriculture and forestry, travel sectors and also on financial institutions themselves. Europe, and especially the UK, have implemented legislations to progressively mitigate CC, despite the delayed ratification of the Kyoto protocol. These legislations to date focus on GHG emitting sectors such as energy, oil and gas, manufacturing, amongst others. These regulations would have other impacts on the assets of financial institutions. In response to CC, countries may initiate measures of adaptation and mitigation. Financial institutions can use their influence on world economies to also implement similar measures. Adaptation directly reduces the impact of CC on assets and liabilities (e.g. flood defence). Mitigation actions may not have measurable financial benefits but may be considered by the private sector as the only way to eradicate the CC issue. This report explores the potential impact of such measures on future assets and liabilities. The report concludes with a set of recommendations to ALM experts (mostly actuaries) on how to incorporate CC in their ALM projections.