You probably know the story of the frog being cooked alive in a pot of water but not realising it, because the heat was being turned up so gradually. When it comes to climate change, we are seeing more about it in the news – but are we really doing enough to stop it? Or, like the frog, are we doing nothing to turn down the heat, not knowing our fate?
Pension actuaries may not believe they have the power to help or to raise awareness of Resource and Environment (R&E) issues, or make their industry greener, but a recent paper from the Institute and Faculty of Actuaries (IFoA) on this subject is a first attempt to show they hold some sway.
The paper notes that R&E issues are unlikely to be the top issue for pension schemes, but they should be considered when looking at Integrated Risk Management as part of the longer-term funding considerations. Effects on funding assumptions, covenant strength, and investment returns all need to be considered.
Funding assumptions
Financial and mortality assumptions are likely to be affected by R&E issues, but these effects will only be visibly demonstrated over the long term. The IFoA is commissioning scenario analyses to help actuaries, trustees and companies understand the potential impact of these issues on investment returns, market yields and inflation expectations, and hence on pension scheme funding. Such factors could also affect the assumptions used by insurers leading to movements in buyout pricing.
Mortality rates may either improve or decline due to climate change – a reduction in cold-related deaths during winter may be offset by an increase in heat-related deaths, or deaths due to extreme weather events. It’s also plausible that attempts to mitigate climate change lead to an increase in mortality rates, with green-focused governments precipitating a resource-constrained economy, or increases in food prices leading to poorer nutrition and less spent on healthcare.
Covenant strength
Covenant strength is crucial when considering both funding and investment strategies for schemes, but R&E issues are difficult to quantify and therefore they may not be reflected adequately in covenant assessments. When assessing the covenant of a sponsor, trustees should ask the adviser to include R&E issues. By looking at how various areas of the business could be affected, it may be possible to assess how vulnerable a sponsor would be to run a business effectively in line with international targets.
Investment returns
Future investment returns are also likely to be affected by R&E issues. Examples of potential impacts might include changes to the energy sector, such as a movement from oil and gas to more renewable sources, falling property returns due to increased damage from flooding and storms and reputational damage on specific companies because of higher than acceptable levels of pollution. A resource-constrained economy could also lead to falling investment returns.
With enough careful observation, persistent efforts at prevention and by ensuring that the issues are considered by pension schemes, actuaries can help to curtail the effects of climate change or at least slow it considerably until a long-term solution is established. After all, a watched pot never boils.
Chris Mason, Consultant and Actuary at Quantum