Esther Hawley and Sandy Trust on the IFoA’s new guide for actuaries working in defined contribution pensions, and why such schemes should commit to net zero today
Three years ago, the IFoA published Climate Risk: A Practical Guide for Actuaries Working in Defined Contribution Pensions (bit.ly/3xJYk2K). At that time, public and political awareness of climate change was significantly lower – climate risk was a new concept for many working in long-term savings, and few schemes had made changes to investment strategies.
Things have changed. There is now a high level of public concern around sustainability and climate change, as the physical impacts of climate change become more visible. Led by the UK, politicians globally are committing to net-zero policy objectives to mitigate the physical risks and accelerate the global energy transition, with its associated risks and opportunities. The IFoA supports these policy objectives, recognising that a rapid move to net zero is the most cost-effective action we can take to mitigate the risks of climate change.
The physical and transition risks associated with climate change are now well recognised by UK policymakers and regulators as financially material, with new regulation having come into force and further regulation expected in the future. In the UK, these regulations mandate the management of material financial risks associated with climate change. However, the pace and scale of physical climate change and the global energy transition are unprecedented, and may not be captured by traditional risk models. This reinforces the need to understand how these risks may impact portfolios, by undertaking climate change scenario analysis.
Almost every nation has committed to limit global warming to well under 2°C, and preferably 1.5°C, compared to pre-industrial levels. To achieve this, it is necessary to balance global carbon emissions produced with those absorbed from the atmosphere by the middle of the century. This is commonly referred to as ‘reaching net zero’.
There is increasing recognition of the importance of pensions investments in supporting the transition to net zero, given the increasing role and importance of defined contribution (DC) pension funds as asset owners. A range of industry initiatives – such as the Paris Aligned Investment Initiative (bit.ly/3tiykIb) and the United Nations-convened Net-Zero Asset Owner Alliance (bit.ly/3ttupIZ) – aim to support asset owners with net-zero commitments, for example by providing implementation guidance. Alongside this is the recognition that investment opportunities will arise from society’s response to climate change.
Accordingly, the IFoA has updated its guide for DC pensions; the updated document is a call to action for those charged with governance responsibilities and the actuaries advising them.
It recognises that failing to incorporate climate change considerations into DC default investment strategies risks poorer financial outcomes for members, and legal action against those charged with governance of investment strategies. This document also recognises the critical role that DC pension schemes will play in supporting the transition to net zero.
Put simply, the transition to net zero will not happen without the support of pension schemes. Given the increasing materiality of DC schemes in the financial system, the decisions we make on what to support with this capital and the engagement we have with investee companies can make a profound difference to the future world we will live in.
Several large schemes have now committed to net zero, underpinned by investment beliefs that this will lead to better financial returns for members, and contribute to creating a future worth retiring into. Some have worked with investment managers to develop solutions, meaning that net-zero investment solutions are now increasingly available for DC schemes. We call on actuaries working with DC schemes to join this ‘race to zero’, make a public commitment and start implementing appropriate strategies today.
Esther Hawley is a principal at Barnett Waddingham
Sandy Trust leads EY’s Sustainable Finance Consulting team and is deputy chair of the IFoA’s Sustainability Board