Systemic climate risks are underpriced

Hello,

For today’s newsletter, I’ll once again go into syndication mode. The following post is my first of many forthcoming contributions to Renaissance Philanthropies' ARC initiative: Advancing Research for Climate Emergencies.

In the post, we discuss how active intervention strategies in climate systems can act as an essential hedge vis-à-vis systemic climate risks and why allocators of climate-focused capital should direct funding towards them as a form of portfolio insurance (as well as for countless other reasons). Enjoy, and be sure to subscribe to ARC’s Substack, too.

In advance of the 2008 financial crisis, financial firms like Lehman Brothers and Merrill Lynch invested and underwrote significantly against flawed models that assumed low correlation among mortgage defaults. When defaults soared as the crisis began, contrary to their models’ predictions, senior tranches of debt thought to be “safe” became extremely risky, extremely quickly. This led to rapid downgrades, losses, and bankruptcies as turmoil in the U.S. mortgage-backed securities markets spread to equities, commodities, and international markets. And the rest is history, the fallout of which the world is still recovering today.

The real risks are underresearched and therefore, underpriced

A central, enduring lesson from that financial crisis and other crises in general is that the more complex the system, the more pronounced the uncertainty as to whether even the most sophisticated models can accurately represent systemic risk. As described by the Rocky Mountain Institute:

The perils of this dynamic are even greater in Earth’s climate systems. In 2025, as we learn more about the risks posed to Earth’s climate by climate change, we’re realizing that some of the most urgent, structural risks stem from the complexity and interconnectedness of Earth’s climate system. These remain dramatically underpriced, and we’re not properly preparing for them. Not even close.

Many components of Earth’s climate system act as buffers against changes in others. For example, as carbon dioxide emissions have increased, ecosystems such as Earth’s oceans and forests tend to act as carbon sinks, absorbing significant volumes of excess carbon dioxide. While the ocean has absorbed massive amounts of carbon—30%+ of human-produced carbon dioxide emissions since the Industrial Revolution—we now know that there are limits to the Earth’s ability to maintain equilibrium. And these are limits we’re pushing, as global warming is set to surpass 1.5° C soon while on a path towards 3° C.

While the headline risks of climate change are increasingly discussed and estimated, what we’re not adequately appreciating and pricing in from a risk perspective—and what we’re certainly not sufficiently prepared to navigate—are the risks of knock-on effects and breakdowns in key components of Earth’s climate system. Returning to how oceans and forests act as buffers that maintain climate system equilibrium, worrying signs of a breakdown in normal climate system interactions are emerging in 2025. Earlier this year, scientists monitoring forests in Australia released research suggesting that those forests may have stopped acting as net absorbers of carbon. Similarly, there’s mounting risk that global warming will unlock massive amounts of methane—a stronger driver of near-term warming, pound for pound, than carbon dioxide—from permafrosts and oceanic regions.

Other examples abound. Recent research suggests a moderate to severe risk of a slowdown, if not a complete collapse, of the Atlantic Meridional Overturning Circulation (AMOC). AMOC is sometimes referred to as the climate’s circulatory system. A slowdown in or collapse of AMOC would—as one example of the global destabilization it could unleash—drive significant disruptions to agricultural productivity in Northern Europe and shift monsoon patterns in many global regions, impacting up to 2 billion people.

Whatever the potential tipping point in dozens of different climate systems in question, the fallout of systemic changes isn’t confined to a warmer world or extreme weather. Whether one focuses on agricultural yields, threats to coastal infrastructure, human health, or the viability of climate mitigation efforts like building more clean energy infrastructure, all of it is a risk if tipping points in climate systems are triggered. As one more example germane to decarbonization, an AMOC collapse could drive significant cooling in Europe, leading to massively increased energy demand and increased fossil fuel consumption, counteracting decarbonization efforts.

Even if we discount the risk of an AMOC slowdown or shutdown by a factor of ten, it’s far too much risk to bear without a response plan.

Underappreciated correlations threaten collapse, and we’re uninsured

The current mode of planning for the significant society-wide disruptions that systemic climate risks pose is at best insufficient and, less charitably, entirely incoherent. Future estimates of the cost of climate change damages are already staggering (mounting to trillions of dollars of losses forecast out to 2050 and beyond, or a 14.5% loss in gross domestic product, as estimated by Moody’s). Even these figures may be understated, insofar as they likely don’t fully characterize correlations between climate systems and how they influence one another.

Unfortunately, today, there is next to no real response strategy to manage, mitigate, or even reverse course on key risks. The closest the world has come thus far is in estimating and earmarking capital towards “loss and damage” funding. At COP27 in 2022, the United Nations established the Loss and Damage Fund, a climate finance mechanism designed to help developing countries mitigate the irreversible impacts of climate change. The Fund became operational in 2023, with the World Bank serving as its interim host.

While well-intentioned, the loss and damage idea itself is an obfuscation. With trillions of dollars in losses and damages forecasted out to 2050 and beyond, there’s an unimaginable scale of society-stopping disasters, ranging from mass human displacement to shifts in entire arable land regions and agricultural supply chains, collapsed ecosystems, and more at stake. And yet, the world’s best proposal to plan for a future characterized by catastrophic loss and damage amounts to a bookkeeping exercise. None of this is a commensurate strategy to deal with the scale and scope of imminent, systemic risks.

Even if loss and damage funds did flow in line with what countries committed, simply shifting capital from countries with relative means to absorb losses to ones without those means is not a serious strategy for navigating a future in which climate change wreaks havoc on entire countries and the global economy. Failing to research and develop strategies and systems to intervene directly in Earth’s climate systems to stave off compounding breakdowns is a much larger hazard than any potential “moral hazard” from well-governed scientific research. Real insurance against future climate risks can’t be confined to moving capital around, or even to traditional insurance products, like catastrophe bonds. Here’s what better looks like.

What better looks like: Accelerating research into interventions

In almost all robust economic sectors, especially in health and finance, paying small premiums to guard against catastrophic losses is commonplace, to the extent that the global economy is unimaginable without the sprawling insurance and reinsurance industries. It’s time to develop similar systems to prepare for a future marked by systemic climate risks. With respect to systemic climate risks, insurance will involve intervention and prevention mechanisms more so than financial products and instruments alone. Whereas loss and damage funds are a way to provide compensation after collapse, physical intervention and prevention mechanisms can ideally prevent collapse. That’s the real insurance required vis-à-vis systemic risk.

Just as some financial firms proactively and successfully hedged their exposure to mortgage-backed securities during the financial crisis in 2008, managers of climate-focused portfolios can “hedge” against serious losses and lay the foundation for greater upside across all their philanthropic giving by contributing to comprehensive climate stabilization. Examples of proactive strategies designed to provide more meaningful insurance against and opportunities to avert foundational climate breakdowns include:

• Sulfur tracking program: Creating new technologies for monitoring, modeling, and modifying the effects of tropospheric sulfur emissions and ensuant climate system dynamics, including how sulfur dioxide historically and presently offsets warming.

• The Arctic Climate Emergency Response Initiative: Developing a set of Emergency Climate Options to address the three of the most imminent tipping point risks (the melting of the Greenland Ice Sheet, sea ice loss, and permafrost thaw) and accelerating research needed to prove, or disprove, their effectiveness, feasibility, and safety.

• Planning for Catastrophic Climate Risk: Developing robust, transparent, low-cost, and easily updated tools to assess catastrophic climate risks and the frameworks to make emergency decisions, even under deep uncertainty.

Building a portfolio approach with high-leverage insurance opportunities

The most succinct way to underscore the scope of the opportunity at hand is to understand that all we stand to gain is effectively equal to everything we stand to lose. Since systemic climate risks threaten the fabric of the global economy, the scope of the opportunity to reduce them has a total addressable market roughly equal to it.

The time is also decidedly now. No matter how improbable certain systemic risks to Earth’s climate system may seem, the risks are definitively not zero. This week, Iceland specifically called out the risk of an AMOC slowdown or shutdown, marking the first time a tipping point in a component of the Earth’s climate system has been formally brought to the attention of the National Security Council.

Fortunately, even relatively small investments in prevention and intervention work double as a kind of portfolio insurance for climate philanthropy, and really all climate and clean energy investment, at large. Many programs philanthropies, government organizations, and even private portfolios invest in are all imperiled by systemic climate risks:

• Agriculture: The billions of dollars spent on developing more drought-tolerant and resilient crops could be imperiled in a world that’s more than 2 °C warmer and sees drought and monsoon patterns disrupted entirely.

• Health and poverty: If additional, extreme warming is “unmasked” as sulfur dioxide pollution decreases in Southeast Asia (as one of many risk examples), it could render all human health and economic development funding in those regions far less effective.

• Biodiversity: Considerable attention is increasingly and rightfully paid to preserving biodiversity across ecosystems like the Amazon. If that ecosystem collapses entirely, well, you get the idea.

The resilience of climate investment and work at large is dependent on the resilience and stability of Earth’s climate systems. Climate philanthropy, for instance, is an eleven-digit dollar engine that already moves the needle on mitigation and adaptation efforts meaningfully. That work deserves an insurance layer of small, uncorrelated bets to preserve system stability.

For climate capital allocators, contributing even 1–2% of budgets to systemic-risk research and development of governance frameworks can offer a high-leverage “insurance premium” to protect against trillions of future losses and safeguard the efficacy of capital allocated to mitigation and adaptation efforts. It’s also worth noting that philanthropy is uniquely well-positioned to kickstart and accelerate this work. Philanthropy is at its best when it moves first, helping governments and the private sector follow.

Hasta la vista,

— Nick