Glossary term
Climate Scenario Analysis
Subject: Sustainability and ESG, Climate Risk
Also known as: Climate stress testing, Climate scenario testing
Climate scenario analysis tests how a business, portfolio or economy might fare under several possible climate futures, such as different warming paths and policy responses, in order to judge resilience.
Explanation
Because the future of climate is uncertain, the method does not predict. It sets out a few plausible pathways, for example an orderly cut in emissions, a late and sudden policy shift, and a world with little action and high warming. The firm then estimates the effect on revenue, costs, asset values and credit losses under each. Scenarios usually come from public sets, such as those published by the Network for Greening the Financial System, and run over 10 to 30 years or more. Climate stress testing is the supervisory form, where regulators prescribe the scenarios and ask banks and insurers to report results. Data gaps and the long horizon are the main weaknesses. Boards read the results to see which strategies and exposures break under which conditions.
Example
An insurer models its property book under a low-warming and a high-warming scenario to 2050. In the high case, expected claims from storms and floods rise by about a third, and some regions become hard to insure at current prices. The board uses the result to review underwriting limits and reinsurance purchases.
Not to be confused with
- Stress Testing
- General stress testing applies a severe shock over a short horizon. Climate scenario analysis follows long-term pathways with gradual and uncertain effects.