The Ongoing Battle Against Climate Change
In a world increasingly defined by the specter of climate change, it is imperative to grasp the gravity of this global challenge. The United Nations defines climate change as ‘the long-term shift in global temperatures and weather patterns.’ It is a phenomenon that has been on the rise since the 1800s, largely driven by human activities such as the burning of fossil fuels. As a result, global temperatures have surged by over one degree Celsius during this period.
The impacts of climate change extend far beyond rising temperatures and erratic weather patterns. They cast a long shadow over various aspects of our lives, including life expectancy, government spending priorities, and economic growth. These macroeconomic variables have intricate connections with the climate crisis, raising questions about how this crisis will impact future valuations of Public Service Pension Schemes (PSPS).
Uncertainty and the Need for Scenario Analysis
While it’s clear that climate change will have consequences, the extent and nature of these consequences remain uncertain. This uncertainty hinges on factors such as current and future mitigation efforts and their effectiveness. To shed light on potential outcomes, scenario analysis becomes a valuable tool.
Exploring Different Scenarios
To gauge the potential impact of climate change on PSPS valuations, experts have explored three distinct scenarios. These scenarios paint different pictures of the world in 2100, based on climate outcomes. They are:
- Orderly Transition: A future where climate change is managed with relative ease, leading to a greener, low-carbon economy.
- Disorderly Transition: A scenario marked by struggles to address climate change effectively, resulting in chaotic consequences.
- Failed Transition: The bleakest scenario, where climate mitigation efforts fail, causing severe repercussions.
Analyzing Risk Types
Each scenario considers two main types of risks emanating from climate change:
- Physical Risks: These arise due to changes in temperature and extreme weather events, affecting everything from infrastructure to public health.
- Transition Risks: Stemming from efforts to transition to a greener, low-carbon economy, these risks are primarily linked to policy and financial market changes.
Evaluating the Scenario Outcomes
The scenario analysis provides a lens through which to assess the potential implications of climate change on key valuation assumptions. For example, many experts anticipate climate change effects on gross domestic product (GDP) growth. These effects play a crucial role in determining the SCAPE discount rate used to set employer contribution rates for unfunded public service pension schemes.
A Glimpse into the Future
To provide a clearer perspective, we compare the scenario outcomes to a baseline projection. We calculate this baseline as the expected cost of future benefits using the standard assumptions from the 2020 PSPS valuations. Notably, for the funded Local Government Pension Scheme (LGPS), actuaries have already begun to consider climate change risk in their 2022/2023 valuations.
What Lies Ahead
In the months to come, the Government Actuary’s Department (GAD) will finalize valuations for all public service pension schemes and present them to clients. These evaluations will serve as a vital tool for clients and stakeholders to understand the risks their schemes face due to climate change.
For those seeking more tailored insights and analysis, GAD is open to further discussions. It is a pivotal step in ensuring that we are well-prepared to address the ongoing challenges posed by climate change.