Pension funds ‘dramatically underestimating’ climate risks, researchers warn

A new report from the Economics of Energy Innovation and System Transition (EEIST) project, led by the University of Exeter, found that current net-zero transition models used by pension funds assume that existing climate-related trends will continue gradually, but fail to account for various “tipping points” that could trigger severe climate and ecological breakdown.

Tipping points could also deliver positive disruptions, such as the rapid development of new green markets. Nonetheless, pension funds are failing to examine many of the risks and opportunities of the net-zero transition.

“Our paper sets out how pension funds can fundamentally reassess their strategic risk indicators,” said co-author Jack Oliver, from the University of Exeter. “Pension funds must rise to this challenge, even if it means changing the way investment decision-making is framed.

“We recommend pension funds examine their plans to assess how far they reflect plausible future events, given the radical uncertainty financial markets face from climate change – much of which simply cannot be modelled. By doing this, they will thrive on the way to a net-zero world.”

The report calls on pension funds to consider all the potential impacts that future policies or market shifts might have, even in a financial value cannot yet be applied to it. Indeed, the report notes that many modelling scenarios and frameworks used by pension funds “largely exclude” physical and transition risks as a result of the climate crisis, with many solely focusing on the financial impacts.

It also states that pension funds should adopt “decision-useful climate scenarios” – using real-world scientific developments and narratives to strengthen transition plans that can also be adapted as scenarios shift and change.

The report proposes that the EIST’s Ten Principles for Policy Making in the Energy Transition are followed. These include creating better investment and regulatory frameworks, ensuring a “Just Transition” is accounted for and considering both opportunity and risk as the transition takes shape.

The findings echo recent reports that warn that the pension sector is relying on inadequate data and modelling when drawing up transition plans.

Flawed financing

Last month, research from Carbon Tracker found that widespread reliance on “flawed research” means that investment decisions today are ignoring the economic and physical effects of a changing climate. As a result, pension funds are risking the retirement savings of millions of people.

The research found that many pension funds use investment models that predict global warming of 2C to 4.3C will have minimal impact on GDP and portfolios. Indeed, some institutions are using modelling that claims that even a 7C rise in average temperatures would see economic growth continue. Carbon Tracker argues this will not be the case.

Currently, UK-based pension schemes have more than £88bn invested in fossil fuel firms, the equivalent of £3,000 per pension policyholder. That is according to Make My Money Matter, which analysed the fossil fuel investments of more than 50 of the nation’s largest pension schemes.

Issues aren’t just isolation to energy and carbon. Just one-fifth of pension funds and providers taking part in the world’s largest net-zero business collaborations have comprehensive plans to tackle deforestation, campaigners claim.