Climate change is a huge subject and tackling the risks that it brings in the context of pensions can be daunting. It can be hard to know where to begin. Where are the risks and what opportunities might it bring? Climate change scenario analysis can help to make climate change risk more tangible and easier to build into your decision making.
A future that will be different from the past
The way that climate scenarios are constructed is different from scenario analysis you may have seen before: looking backward for inspiration doesn’t help here.
LCP’s climate scenarios, developed in conjunction with Ortec Finance, are built on a global economic model that looks at alternative versions of the future, and plays through the physical and economic consequences of more frequent and severe extreme weather events and the reallocation of capital away from carbon-intensive industries.
The scenarios are not predictions, but are possible futures that allow us to look at how the world could develop and how your scheme might fare.
Climate pathways: Dividing possible futures into manageable chunks
Most climate scientists and economists agree that if atmospheric concentrations of carbon dioxide continue to increase, there will be increasing physical climate effects, particularly beyond 2030. Our climate scenarios focus on two possible alternative pathways for future rises in global temperatures, as shown in the chart:
- One in which carbon emissions continue, and physical impacts occur with increasing frequency and severity; or
- One in which world governments, companies and individuals successfully implement changes to policy and behaviour, reducing net carbon emissions to zero in line with the Paris Agreement and thereby avoiding most, although not all, of the increase in physical risk.
Temperature change above pre-industrial era (1850-1900)
Projecting the impact on your scheme
Over the long term, there are significant economic consequences under either of these possible futures. The climate modelling from LCP and Ortec Finance goes one step further to look at how financial markets might react in either scenario, modelling returns on all major asset classes. The modelling anticipates that markets react strongly to trends and that sentiment adjustments can be severe. So while climate change is a long-term issue, some of that reaction is likely to affect market pricing sooner, probably well inside the next decade. That timeframe is certainly soon enough to affect a DC member in their 50s or a DB scheme working towards a long-term objective by 2030.
So what can climate change scenarios tell me?
Climate change is a wide-ranging subject that will play out globally over decades, so it can be a challenge to work out how climate change risks should factor into your day-to-day decisions.
Climate change scenarios can help you to divide and conquer this challenge, making it easier to embed climate change risks in your governance and decision-making. They can help you to identify the right questions, sense check the answers and prioritise subsequent actions.
Our clients have found that climate change scenario analysis can deliver:
- A deeper understanding of the ways that climate change could play out and how that could affect your scheme over time
- A sense of how material the consequences might be for your scheme – both in the short term and for the longer-term journey plan
- Ideas for good questions to ask your investment managers, to make sure they are aware of climate risks and are protecting your interests
- A good starting point for exploring how a DB scheme’s sponsor could be affected by climate change, by considering each scenario in turn
- A great opportunity to sense check a DB scheme’s journey plan and test whether contingent planning will be effective to recover from bumps in the road – be that due to climate change risks or something else
Climate change analysis is just one of a wide range of climate-related actions that trustees should be considering, in line with upcoming legislation and guidance from The Pensions Regulator. However, we think it is one of the actions worth doing early in the process as it will help bring focus and insight to many of the other actions. LCP has prepared a summary of the wider actions to consider, available here.
Keep in touch
