Effects of Climate Change on Financial Sector
Burning hydrocarbon e.g. fossil fuel emits carbon dioxide and other greenhouse gases like methane. Nature has its own ways of absorbing these green house gases. But since Industrial age we have been emitting green house gases at a higher rate than the capacity of nature’s sink. These green house gases trap heat, affecting the environment and ecosystem in numerous ways.
Figure [ 1 ]: Historic Atmospheric CO2 Concentration (ppm) for 1,000 Years
The preindustrial carbon dioxide concentration in atmosphere of around 280 ppm has risen to current level of 386 ppm. The Intergovernmental Panel on Climate Change (IPCC) project CO2 ...view middle of the document...
Insurance, Re-Insurance, Life Insurance and Pension
Climate change will bring to geographic and demographic changes in various parts of the planet. Mortality and morbidity will be affected by milder winters, increased temperature spreading tropical diseases and pests and extreme weather events. Life insurance and pension industries use financial models based on financial assumptions on the links between economic variables, such as investment return, interest rates, inflation, and salary increases, which have historically been stable. In post colonial era we have lived in a time of steady economic growth and prosperity. In UK’s perspective, The UK Chartered Institute of Insurers predicts that weather related damage will be larger than economic growth by 2065 (Nick Silver, May 2003, The Actuary). The insurance industry will be the first to bear the cost of such unprecedented events and will be passing the liabilities to the common people in terms of increased premium.
Sectors with Potential Regulatory Pressure
After the Copenhagen Summit, Governments all over the world have come to political agreements, at least morally, that climate change is a reality and we should take action to nullify its effects. As per the Copenhagen Accord and other announcements from the Governments around the world there will be an effort to ‘control’ GHG emissions. Hence, the industries responsible for creating GHG emissions will be asked to take the first steps. The industries which will be affected the most by modified policy norms are fossil fuel power generation, oil and gas extraction and refinery, manufacturing requiring high amount of energy, chemical, cement, ceramic and glass, paper pulp, Transportation etc.
Asset Liability Management
Asset Liability Management is very crucial to the financial business as most of the assets and liabilities translate into medium to long term cash flow projections. Typically, a bank lends funds over a period of 20 years. A life insurance company receives regular premiums for periods of often higher than 30 years to guarantee over the mortality or the morbidity (invalidity) of an individual. A pension fund receives contributions from individuals aged 18 to 60 and will invest these contributions into assets so that it is able to provide adequate retirement for these individuals at retirement age. (Impacts of Climate Change on Financial Institutions’ Medium to Long Term Assets and Liabilities by Louis Perroy, 2005). Climate change will change the input variables of several assumptions on which these industries stand.
New Opportunities: CDM Projects
As IPCC, UNFCCC and Governments around the world is trying to find solutions to control GHG emissions and several industries are finding opportunities in this. ‘Cap and Trade’ policy has enabled companies in developing countries to import technologies from developed countries. This has made some projects economically profitable which were not otherwise.
Several CDM projects...