Smaller defined benefit (DB) schemes are at risk of greater financial losses due to climate change risks than larger schemes, according to analysis by Broadstone.

Modelling by the consultancy found that UK DB schemes face varying levels of climate change risk depending on their size and maturity, but smaller schemes with under £5m in assets and less mature schemes are particularly exposed.

Its climate modelling analyses the typical investment mix of different types of DB schemes, using data from the Pension Protection Fund’s Purple Book 2024 and climate scenarios from Ortec Finance to estimate how a portfolio might be affected by climate change.

The research showed that these smaller schemes could see returns fall by 16.9 per cent over 20 years under a 3°C warming scenario, compared with a 13.8 per cent decline for larger schemes over £1bn.

When comparing larger schemes to smaller schemes, smaller schemes tend to have a higher exposure to return-seeking assets, according to Broadstone, which could be due to the simplified investment strategies they typically implement, it said.

The research also showed that less mature schemes, those with fewer than 25 per cent of members retired, face nearly twice the risk of negative performance compared to mature schemes, with over 75 per cent of their members retired, experiencing a -15.7 per cent versus -6.7 per cent decline over the same period.

Broadstone said this is to be expected, as mature schemes tend to shift their focus from return-seeking to matching assets, helping to hedge against interest rate and inflation risks, reduce funding volatility, and lower their exposure to climate change risk.

The firm defines climate change risk as the difference between the returns a scheme would normally expect, using capital market assumptions, and the returns expected if the world warms by 3°C by 2100 and measures the difference in performance of a scheme’s assets under these two scenarios.

For most DB schemes, the analysis revealed that climate change risk shows up as a slow reduction in expected returns over time, which speeds up as the physical impacts of climate change start affecting investments and markets begin to fully account for climate risks.

The seriousness of this risk depends on how much of the scheme’s money is in return-seeking investments, such as equities or diversified growth funds, and how long it stays in those assets.

In response to these findings, Broadstone said that climate scenario modelling is becoming “increasingly important” for DB pension schemes to measure, monitor and manage climate change risks.

Broadstone investment and climate risk director, Deon Dreyer, said that smaller and less mature schemes are “notably” more exposed to potential disruptions to asset return expectations because of climate change due to their greater allocations to return-seeking assets.

Meanwhile, Dreyer said that less mature schemes will typically be exposed to return-seeking assets for a longer period as they try to generate sufficient returns, potentially exposing them to greater climate change risks as the effects of climate change play out over time.

And he noted that as the severity and frequency of risks increase over the coming years, there are likely to be material impacts on traditional growth assets such as equity, real estate and infrastructure.

Given this, he argued that scenario modelling could help schemes and trustees measure this “previously neglected” risk and incorporate it into their investment strategies.

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