In addition to policy mandated by government, what can the pensions industry do to make a real difference in the battle against climate change?
Introduction
Climate change! The threat to our way of life and perhaps very existence. The greatest danger to humanity (with the possible exception of the war in Ukraine) since the end of hostilities in 1945. It is something that none of us can escape or ignore, both personally and professionally. In fact, it can be argued that the pensions industry is affected by climate change more than most, both in the potential impact but also in the ability to tackle the problem.
Pensions are all about the future, and the impact of climate change is likely to only get worse as time goes on if we do not step up to stop it. However, the largest asset that most people own is their pension (with the possible exception of their property) and thus the industry as a whole has a unique amount of power to affect policy and outcome, given the enormous assets for which it is custodian. The following explores just a few of the ways in which this change could be brought about.
Pension industry working practices
The first and perhaps most obvious way the pensions industry can help to tackle climate change is to adapt its working practices towards greener policies. This is by no means limited to the pensions industry, but for pension-orientated companies that tend to hire a medium to large-scale workforce (with some of the larger insurance firms employing thousands of staff), their contribution can make a difference.
COVID-19 started a trend of moving towards a less office-based working environment, which has almost certainly had large positive environmental impacts. Working from home means fewer journeys to and from the workplace, less need to heat or, in the much less likely scenario of the UK having warm weather, keep cool large office spaces and a move to paperless working (i.e. almost everything being kept on internal computer systems without the need to print forests of paper) are just a few examples of this positive environmental change. If pension firms can continue with the change and even improve on it (for example by encouraging cycle[1]to-work schemes or car-sharing arrangements when it is necessary to travel to the office) an important step towards fighting climate change will have been taken.
Also, there is an opportunity for the pensions industry to alter the way it meets disclosure requirements when it comes to scheme member communications. Many communications are still sent as bulk postal deliveries, simply because this is how it has always been done. However, if the method of sending was switched to electronic communication via email or the internet, it would save not only the paper/printing environmental cost but also the pollution produced from the delivery vehicles needed to send physical copies. Changes can also be made by greater use of electronic signatures (for example for investment instructions) and removing the need for scheme members to sign forms when possible. Naturally, a balance must be struck between environmental concerns and member security. It would also be necessary to ensure members who could not access electronic communications could still receive postal copies. However, with technology’s ever increasing reach into our lives, fewer and fewer people are dependent on such communication methods.
ESG investing (part 1) – greater use of positive screening Environmental, social and governance (ESG) has been a cornerstone of the pension industry (especially the investment aspect) for quite some time. In 2019, scheme trustees were first required to state their ESG considerations in their statement of investment principles, and the ESG consideration requirements have only increased since. This is of particular importance, as according to the ONS the market value of defined benefit and hybrid pension scheme was c.£1.45 trillion on 30 June 2022. This is a sizable market share in itself, but when it is considered that these types of pension scheme now account for less of the total industry share than in the past (with defined contribution pension schemes becoming the norm for most occupational and all private pensions), the assets under the management of the whole pensions industry are enormous and growing. As such, the pensions industry can command considerable influence in this area.
There is a considerable push towards ‘negative’ screening when it comes to investment opportunities (i.e. taking steps to remove shares in companies, for example that actively do harm and fail ESG criteria by causing too much pollution, from portfolios). However, a greater impact could be achieved by encouraging more ‘positive’ screening, whereby scheme trustees and their investment advisers actively seek ESG-friendly investment opportunities.
The positive environmental impact of such a strategy could be limitless. Greater investment in companies that promote action against climate change would naturally help the environmental cause by increasing the assets/ funding available to such companies. In itself this would be useful but money has a way of attracting money. As such, initial investments by scheme trustees adopting ‘positive’ screening will surely encourage other investors to put their money in such assets. All that is needed are a few trend-setters to start.
ESG investment (part 2) – invest where it will make a difference
It is sometimes perhaps a forgotten fact when it comes to pension investments, where the main goal is (and should be of course) the achievement of strong and sustainable growth for scheme members, that there is huge potential for the recipients of the investments (i.e. the companies into which pension investments purchase shares/stakes).
Many pension investment strategies are centred around medium to large companies in developed economies such as the US or Europe. However, there could be massive benefits if scheme members had more opportunity to invest in smaller and developing economies to allow some of the capital to help meet their growth needs. Pension investments used to build cleaner power stations (as one example) in the developing world would have obvious environmental advantages and could potentially lead to larger returns given the increased perceived risk of the investment. Once started, the process would have a compounding effect, as these countries would become richer and naturally move towards greener policies and practices. This has been the trend ever since the industrial revolution; as a nation increases its wealth, it becomes more environmentally friendly both because it can better afford to do so and because its population demands it to improve their standard of living. In addition, there is strong evidence that ESG and sustainable investing practices are what scheme members want and expect.
Annuity providers and annuitant lifestyle choices
Although the annuity has somewhat fallen in popularity since the introduction of Pension Freedoms in 2015, a large number of annuities continue to be purchased, with over 68,500 being secured in 2021/22. This may well increase in the short term due to favourable market factors (such as higher interest rates).
It is well established that annuity providers will offer better rates based on lifestyle choices but these have traditionally been based on poor health/lifestyle circumstances. If annuity providers could be persuaded to offer higher income for a person who makes positive environmental choices (such as opting for walking over driving when possible), then Adam Smith’s ‘invisible hand’ could gently guide retirees into helping combat climate change. The difficulty with this policy would be making it worthwhile and profitable for the annuity providers. However, many companies make decisions based on environmental considerations, so they benefit from positive public perception of these actions. This might be possible in the annuity sector and might be a key deciding factor in a person’s decision to purchase an annuity with one particular provider over another.
Conclusion
Climate change is a problem that affects us all, and the pensions industry is no exception. There are many ways in which the industry can make a difference to the fight against climate change, of which only a few have been explored here. They vary from basic changes in the way companies involved in the industry operate and communicate with their scheme members, to larger changes in the industry’s arguably most powerful tool when it comes to influencing policy: the investment market.
The key to effecting large-scale change in the medium to long term will be to gently nudge people’s behaviours and attitudes and to educate them in the positives that their pension (particularly its investments) can have for the environment. The industry as a whole will also need to learn these lessons and take actions in addition to those that government and regulatory bodies mandate. Otherwise, it may well soon be too late and the fight against climate change could be lost forever.
James Turner, Senior Pensions Administrator at Quantum Advisory