Misleading nature of climate risk advice to pension funds
Actuarial Post 22/11/2023
"EDHEC-Risk Climate Impact Institute newly released research confirms the misleading nature of climate-risk advice given to pension funds; points to flawed use of models and a failure to communicate uncertainty; warns that both markets and investors are underestimating potential climate damages.
UK Local Government Pension Scheme authorities have experimented with reporting on their governance and management of climate risks, responding to challenges by non-governmental organisations and anticipating regulatory developments. Drawing on advice provided by investment consultants, their reports have included simulations of the impact of climate-related scenarios on investments suggesting that portfolios would only be marginally impacted, even in high temperature scenarios.
In a newly released position paper, "Portfolio Losses from Climate Damages: A Guide for Long-Term Investors," Professor Riccardo Rebonato, Scientific Director of the EDHEC-Risk Climate Impact Institute, discusses the (de)merits of the advice addressed to pension trustees and engages with critics who assert that pensions are being put at risk by the flawed research and groupthink of climate economists.
His research concludes that pension trustees have indeed been poorly served by their consultants. He also concurs with critics' views that the estimates of likely portfolio losses due to climate change in the authorities' reports are implausibly tame.
However, Professor Rebonato's research offers a different and more nuanced perspective about how these conclusions have been reached and the use of integrated climate economics models. Importantly:
1. the DICE models, which were designed for policy design, have been inappropriately used for scenario analysis;
2. their modularity means they can be modified to accommodate scenario analysis;
3. there is a wide divergence of estimates by economists regarding the severity of climate damages, challenging the idea that groupthink has led to a tame consensus view.
His research exposes the failure to communicate the huge uncertainty in damage estimates as the most glaring flaw of the advice received by trustees and denounces the non-sensical precision with which some of these estimates have been presented.
Echoing recent and forthcoming scientific publications by EDHEC-Risk Climate Impact Institute, the paper endorses attaching approximate probabilities to climate scenarios. Professor Rebonato warns that not only pension consultants but also financial markets appear to be sleepwalking into the climate crisis, noting:
"Financial markets might be pricing in overly optimistic climate scenarios, indicating a potential repricing risk that trustees should be aware of.""
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Operating from campuses in Lille, Nice, Paris, London and Singapore, EDHEC is one of the world’s top 15 business schools. Fully international and directly connected to the business world, EDHEC commands a strong reputation for research excellence and the ability to train entrepreneurs and managers capable of breaking new ground. EDHEC functions as a genuine laboratory of ideas and produces innovative solutions valued by businesses. The School’s teaching is inspired by its research work and a focus on “learning by doing”, all with the aim of equipping people with the skills to succeed in business.
