The final pension payment is just as important as the next
22 Apr 2020
Climate change threatens trustees’ ability to pay pensions over coming decades. Trustees’ operational response to the COVID-19 pandemic is a blueprint for the kind of forward planning, urgency and purposefulness that’s needed to tackle climate risks today.
One of the issues that most, if not all, pension scheme trustees have had to grapple with through Covid-19 has been their ability to pay pensions. These issues have been largely operational in nature: do we have enough cash in the bank to be able to make payments; can we establish an appropriate liquidity buffer to reduce the risk that markets close; do administration teams have appropriate Business Continuity Plans in place etc. This has been essential as trustees have a fiduciary responsibility to ensure that the benefits due to their members are paid as they fall due.
Trustees have the same duty in respect of every monthly pension payment, to every member of their scheme for the lifetime of the scheme, even if this responsibility is transferred to a third party by way of a risk transfer exercise. From an operational perspective, we can infer that the final pension payment, which may be many decades into the future, is as important as next months’ payment.
Clearly, some issues such as those that have prevailed over recent months can only be dealt with at the time they arise. Trustees need the flexibility and governance structures to allow them to react to prevailing circumstances, as they have done. Trustees can undertake the necessary due diligence on their service providers to ensure that processes withstand stressed circumstances; they can similarly test the resilience of their investment strategy and sponsoring employer to gain level of comfort.
But what should trustees do in the face of a longer-term, systemic threat to their ability to pay pensions?
Mark Carney, in his role as Governor of the Bank of England, has repeatedly warned of the systemic threat posed by climate change to the financial system. The creation of the Taskforce for Climate-Related Financial Disclosures was a critical step forward in recognising this uncertainty, one which should allow investors and markets to make more informed decisions about how they invest. But this is not nearly enough.
The financial impact of climate change
The graphic produced recently by the IMF illustrates the means through which climate risk is transmitted into the financial system and, through the feedback, how this then impacts the economy. We can be quite blunt - these risks are very real.
Illustrating the point further, the CEO of Axa in 2015 remarked that a world with 4 degrees of warming is uninsurable. What he meant by this is that the cost of insurance outweighs the value of the asset that the insurance is designed to protect making the value of the asset nil. We already see this for some houses built on flood plains which have an effective value of zero: who would want to buy a house that regularly floods?
We can therefore surmise that in a 4-degree world, the financial system will have begun to break and there is a considerable risk that trustees will not be able to fulfil their obligation to pay the last pension. At what point this threshold is breached is unknown, but if we know the risk of systemic failure exists, why would any party take actions that serve to exacerbate the risk?
The need for trustees to act
No one single entity is going to solve the climate change problem, but the role of the trustee remains clear; they have to be able to pay benefits to members whether it is now or in 50 years’ time. It must therefore be incumbent on trustees to ensure that they are taking appropriate steps to mitigate the risk that they cannot pay benefits in future. To do otherwise is to contribute to the potential risk of systemic failures somewhere down the line.
Covid-19 has provided trustees with an immediate need to act in the face of a global problem. Climate change is a similar global challenge. Whilst the effects may be more protracted, that does not mean that the need to act is any less immediate.