Climate risk could add £25bn of additional deficit risk to FTSE350 pension liabilities over the next 15 years according to Hymans Robertson in its annual FTSE 350 analysis. To prevent this massive increase in liabilities, climate risk needs to be built into DB funding strategies, claims the leading pensions and financial services consultancy. Funding strategies need to be adopted that minimise the impact of climate risk on pension scheme assets and liabilities, and employer covenants it warns.

To calculate the potential additional liability from Climate Risk, Hymans Robertson considered the impact of three Climate Risk scenarios on FTSE 350 DB funding positions: a smooth and rapid “greenification” of human activity (“smooth transition”), a more delayed and severe response to achieve the same objectives (“delayed transition”) and very little response (“no transition”). It looked at the impact of each of these climate scenarios on the 1-in-20 downside risk being run by the FTSE 350 over time.

The “smooth transition” added the most deficit risk in the short term, with deficit risk increasing by £20bn in 3 years’ time compared to their baseline position. This is driven by the rapid and aggressive policy changes underlying the smooth transition harming DB funding in the short term. However, longer term “no transition” presents DB funding with more risk, increasing deficit risk by £25bn relative to their baseline position in 15 years’ time. Delayed transition introduces the lowest level of additional deficit risk, never increasing deficit risk by more than £10bn relative to their baseline position over a 15 year period.

Commenting on the increasing need for FTSE 350 DB Schemes to manage climate risk, Alistair Russell-Smith, Head of Corporate DB, Hymans Robertson says:

“It’s becoming far more important for corporates and trustees to understand the impact of climate risk on DB funding strategies. It is clear from our analysis that the impact of climate risk on FTSE 350 pension deficits is significant – as much as £25bn of additional deficit risk. Covenants can also be significantly impacted by climate risk, potentially leading to scenarios where additional cash is needed to fund DB deficits at just the time covenant strength is falling.

“While corporates already report and manage some of the “externality” risks associated with their operations, many have also already embraced the Taskforce for Climate Related Financial Disclosures (‘TCFD’). These TCFD requirements are being rolled out to pension schemes, initially those over £5bn and subsequently to those over £1bn, obligating them to manage and report on climate-related risks specifically.”

Explaining how climate risk modelling can help inform better decision making on DB funding strategy, Alistair continues:

“Climate risk could blow a scheme materially off course, introducing additional downside risk and pushing out timescales for reaching DB endgames. Understanding the impact of climate risk on DB funding by using the models we’ve developed can help determine funding, investment and covenant strategies that minimise the impact of this risk on DB funding progression.”