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2020 Teaches Pension Fiduciaries to Prepare for Climate Change

September 3, 2020

Like the COVID-19 pandemic, climate-related events have the potential to impact pension investments and funding obligations, as well as day-to-day plan operations. The adversity that administrators have adapted to this year can provide lessons for building more resilient governance structures for retirement plans. 2020 has made us look more broadly at external risks that can impact pension funds and we’ve learned these should be reflected in our risk management frameworks. This will be particularly important as climate change threatens to affect our economy in new and significant ways.

Although there are many similarities, climate change is a wider category of risk than a pandemic. It can cause sudden disruptions that have a beginning and end like a pandemic – think of the Australian wildfires that had the country reeling from the loss of land and infrastructure until rain finally brought some relief. But climate change also has a long-term horizon. It will build and worsen over time and exacerbate other social and political vulnerabilities. The landscape will also keep shifting as science and technology evolves and as we shift to a low-carbon economy.

Using 2020 as a guide, here are 4 lessons for building climate-resilient pension governance frameworks.

LESSON 1:  Pension plans need to be ready to deal with fast-moving economic crises.

As the effects of the pandemic were mounting, plan administrators learned they needed to be able to make rapid adjustments. Climate events can also happen quickly. Floods, drought, forest fires, and storms can cause a whole host of challenges like evacuations, property damage, and trade interruptions. As we learned this year, plan administrators will be in a better position to handle volatile conditions if business continuity protocols are in place. 

We recommend developing a rulebook or checklist to guide plan governance during a crisis. Consider, what will the main priorities be if plan trustees can’t get to the office, if employees are not working, or if the market crashes? 2020 has given us plenty of material to feed our imaginations as we plan for these potential risks.  There are also many resources available to help plans project the possible implications of climate change.

A business continuity plan for a pension should focus on critical processes such as paying benefits, accessing data, and making decisions. The aim is to protect the fund, maintain compliance, and ensure as little disruption of plan operations as possible during an emergency.

A more sophisticated business continuity plan might be supported by a risk assessment matrix that looks at the likelihood and impacts of potential events. It will also be more effective if those overseeing the pension are in regular receipt of reliable and timely information about the development of these risks. This will ensure that the plans can be implemented quickly as the need arises.

LESSON 2:  Build relationships with subject-matter experts before a climate crisis hits.

Administrators should consider, who is tracking the opportunities for the plan that arise as the economy shifts to low carbon? Who is providing recommendations for avoiding climate-related risks and losses? As regulatory requirements evolve to address climate change, does the plan have access to experts who can ensure the plan remains compliant?

During the worst of the pandemic, some plan fiduciaries complained they did not have quick access to information and were unsure how to reach regulators with questions. They also wanted to know how their peers were reacting to the lockdown. Plans have relied heavily on trusted third-party advisors to guide them through 2020’s upheavals. Certainly, it was better to have strong relationships with experts already in place when the pandemic hit.

Building climate resilience should include solidifying internal networks and establishing relationships with external experts. The Mantle314 team provides independent education on climate developments and recommends climate-resilient strategies to pension clients and other institutional investors. We believe it is important for clients to have direct access to multi-disciplinary experts who can help them make decisions related to climate change. 

There may also be climate experts within your organization who can be brought into conversations about the pension plan. It may be worthwhile to establish a sub-committee for the pension that is charged with overseeing and managing climate change issues. This team can liaise with experts and other stakeholders and provide leadership in the event of a climate crisis.

LESSON 3:  Risk registers should address major economic risks like pandemics and climate change. 

Risk registers often focus on internal, operational issues but fall short with respect to threats from the external environment. Plans should take the time to identify and assess climate-related risks that could impact the fund and build these into a risk register. We also recommend implementing climate change metrics and performance measures sooner rather than later, to support risk management.

According to the World Economic Forum’s 2020 Global Risks Report, infectious diseases are the 10th greatest risk in terms of potential economic impact. Climate action failure is 1st on this list. In fact, 6 of the top ten risks relate to the environment and natural disasters. And yet, many plans’ risk registers do not address these types of threats.

A risk register should document the potential causes of economic and social disruption that might impact the plan and list the internal controls that can be used to help manage those risks. Since we know that climate change is a significant and material risk for the global economy, it deserves a place within the risk management framework.

LESSON 4:  Focus on education to ensure fiduciary duties are not forgotten during a crisis.

Fiduciary duties cannot be set aside during an economic downturn, a pandemic, or a natural disaster. In fact, fiduciary duties are especially critical during a crisis when beneficiaries of the fund are more vulnerable. Prioritizing continuing education is a way to ensure that fiduciary duties are not overlooked when the plan is under pressure. Members of the Board or pension committee need to understand their duties at a theoretical level but should also discuss how these obligations should inform their actions during a crisis.

As the economic impacts of COVID-19 hit, fiduciary duties to act in members’ best interests may have been overshadowed at times by concerns over cost-conservation. Experts expect a flood of litigation to come from the pandemic against long-term care homes, insurers, and the travel industry. It remains to be seen if there will be any legal challenges against plan fiduciaries for the ways the pandemic was handled. We have learned, however, that the middle of a crisis is not the right time to start having conversations about fiduciary duties.

To avoid this risk in relation to climate change, plan fiduciaries should learn about their obligation to identify and address climate-related financial risks and opportunities now. They should have sufficient knowledge about these duties and about climate change to be able to have productive discussions. This will help keep fiduciary duties in plain sight during more stressful times.

For pensions to be resilient, plan fiduciaries should monitor external risks, stay informed by building relationships with expert advisors, and establish robust business continuity plans. The lessons of 2020 can help us prepare for the significant impacts we can expect from climate change. Let’s ensure that during the next crisis, our pension plans are in a better position to weather the storm.