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Speaker(s): Sam Gutterman
A cost-benefit analysis plays a crucial role in social decision-making. This process includes trade-offs between consumption today and potentially catastrophic damages in the distant future. Thus, the application of discount rates is an important element in the quantitative portion of this analysis, especially dealing with issues involving long periods. Where social externalities are involved (costs and benefits not considered in prices set in te private sector), social discount rates are used. Findings can be extremely sensitive to discount rates used.
The objective of this report, sponsored by the Society of Actuaries, is to discuss the factors that affect or should be considered in the development of these rates, with a primary focus on cost-benefit analysis of climate change-related strategies or projects. These involve the selection of mitigation and ex-ante or ex-post adaptation projects dealing with the effects of climate change. The unique set of characteristics involved in climate change analysis are discussed that affect these choices, including ethical considerations such as intergenerational equity.
This report focuses on approaches addressed by economists, especially those based on the Ramsey formula. As evident by a review of the literature, there is no unique set or underlying social discount rates applicable to climate change related issues. It discusses the many considerations and approaches that can be taken.
Because of the large amount of uncertainty regarding the amount and timing of the effects of climate change through the level and volatility of temperature and precipitation, uncertainty and risk aversion also need to be considered. Flexibility regarding the timing of implementation of mitigation or adaptation plans may be needed. Approaches that can be taken to assess its value, especially real option analysis, are described. The effect of these factors (e.g., in response to new technologies) can be used to arrive at appropriate and timely decisions.