The coverage ratios of pension funds could drop by up to 80% if global temperatures rise by 4°C, a new model for asset-liability management has suggested.
The model – developed by Ortec Finance in co-operation with the €19.4bn Philips Pensioenfonds and the €47bn metal scheme PME – assumed that funding levels could still drop by 20% if global average temperatures only rise by 1.5°C above pre-industrial levels.
Speaking at an ALM event hosted by the Dutch branch of the CFA Society, Willemijn Verdegaal – co-head of strategic climate solutions at Ortec and one of the developers of the model – said that Ortec had factored in the economic impact of an energy transition as well as the physical effects of a temperature rise.
“By making assumptions of the impact of climate change on, for example, trade flows and the local energy mix, we assessed the impact on important variables, such as GDP, interest rates and inflation,” she explained.
Another difference with traditional ALM models was that Ortec’s model’s duration was much longer than the usual 15 years, because the physical effects of climate change were expected to become clearer over the course of several decades.
“Climate effects pose a system risk that pension funds have to take into account anyway,” argued Verdegaal. “If sea levels rise, the impact will have an effect everywhere. It would be almost impossible to avoid this through diversification.”
According to Ortec Finance, the 1.5°C scenario would lead to a chaotic energy transition, but resulting in a significant carbon reduction and opportunities for recovery.
However, in the 4°C scenario, the economy would increasingly suffer from extreme weather conditions combined with a one-metre sea level rise by 2100.
This would cause GDP to drop by more than 10% as of 2060 and would be disastrous for the economy and pension funds, said Verdegaal.
She added that purchasing power would also be affected.
According to Verdegaal, Ortec’s results didn’t include a potentially enormous increase of the number of climate refugees, “as the impact would be very difficult to factor into the ALM model”.
Ortec also made clear that a 4°C rise would pan out better for pension funds’ coverage in the short term – up to roughly 2050 – as costs for energy transition would be lower in a ‘business as usual’ scenario.
Verdegaal said that Ortec’s ALM model would enable pension funds to assess how hard they would be hit.
“In addition, schemes can use the model to find out how they can make their investment portfolio less susceptible to certain climate risks,” she said.
In August, Schroders warned that investors had not been paying enough attention to physical climate risks, as opposed to the risks posed by steps to combat climate change.
With temperature rises lagging increases in greenhouse gas concentrations in the atmosphere by around 40 years, further disruption from the effects of changing weather patterns looked unavoidable, the asset manager said.
In an earlier report, Schroders had warned that the world remained on course for a 4.1°C temperature rise, as developments in the oil and gas industry had been offset by a slowdown in low-carbon investments.