Applying the lessons of coronavirus to climate change

As an actuary, I am drawn to the marked effect that coronavirus has had on lifespan in a very short period of time and the issues it raises for pension funds. But there are other factors that could also have a profound impact in the longer term.

Perhaps the most pressing and foreseeable worry is the impact of climate change and its inevitability during the lifetime of the current generation of pension savers.

There is little evidence that UK schemes are taking into account climate change or other far-off risks, most likely because they expect to offload their liabilities progressively to insurers via buyouts

Over the past 30 years, medical improvements have led to a dramatic increase in life expectancy. However, the rate of improvement has slowed recently as people’s lifestyles, particularly in the developed world, have become unhealthier. Obesity, cancer and diabetes have all slowed the rate of progress, but the trend is still one of longer lives.

But is this sustainable? The models that pension funds use appear to think so.

Climate change and longevity

The world’s climate is undoubtedly changing in ways that are unprecedented in human history, and a hotter climate will certainly have implications — mainly negative — for human health.

Water-borne diseases such as cholera are likely to become more common as flooding events increase in frequency. Vector-borne diseases such as malaria will become even more prevalent, as higher temperatures will increase mosquitos’ geographical coverage. Higher temperatures will also lead to an increase in allergens and air pollutants that are harmful to human lungs.

Implications for pension funds

For defined contribution pension investors — who tend to be younger — the amount of time they spend in retirement might be significantly lower than current mortality trends are assuming.

A DC investor in their twenties might well question whether they will need retirement savings that will last them for 30 years. Many are unlikely to retire at all, given the combination of lower savings rates, longer working lives and lower life expectancy.

For defined benefit pension funds, which are already struggling to square the funding circle, reconsidering longevity trends to account for climate risk might be a rare — albeit unpalatable in human terms — positive for their liability valuations.

Such action might lead to materially different funding discussions, especially around the levels of cash support needed from plan sponsors to recover from the current crisis, as well as the levels of investment risk needed to repair their funding holes.

Climate change: possible scenarios

If climate change is very severe, pension funds’ investments will fall in value, but so will their liabilities. Under this scenario, there could be a neutral overall effect, though this would be the worst-case scenario in human terms.

If climate change is pronounced and a pension fund has invested in climate technologies, its assets could hold up in value or even rise, while its liabilities would fall.

If, on the other hand, governments ramp up carbon prices — resulting in huge emissions reductions and less severe climate change — longevity rates will continue to increase due to the cleaner environment.

This would be ‘bad’ for a pension fund’s liabilities, but the option is still there to invest in climate technologies to provide some offset, or gain, on the asset side.

Across Europe, pension funds are grounded in the concept of prudence. They have been prudent with respect to longevity, in assuming that it will continue to rise and making sure they have enough money to honour their liabilities.

But it is arguable whether this approach is really prudent, compelling their sponsors to pay for the worst-case life expectancy scenario, which looks unlikely.

Unfortunately, there is little evidence that UK schemes are taking into account climate change or other far-off risks — beyond doing the minimum regulatory reporting requirement — most likely because they expect to offload their liabilities progressively to insurers via buyouts.

It then becomes a problem for insurers, unless they price in these risks in the buyout deals, and it is hard to believe that they will not.

Nikesh Patel is head of investment strategy at Kempen Capital Management