The impacts of climate change on life insurance and retirement incomes
Is there a material chance that the climate will change? And if so, what are the consequences on investments, life insurance, and retirement incomes?
Accepting that there is a material chance, and in fact we are currently seeing the impacts already, the latter question formed the points of discussion at the 19 November insight session, The Impacts of Climate Change on Life Insurance and Retirement Incomes, presented by Jillian Reid and Ramona Meyricke.
What are climate risks?
Climate risks can be categorised into physical, transition, and liability risks.
- Physical risks come directly from damage caused by weather- and climate-related events due to climate change;
- Transition risks relate to the uncertainty as society moves towards a less carbon-intensive economy, such as changes in regulation, asset values, industries, and employment;
- Liability risks relate to compensation sought, such as through litigation, by those who suffer damage from impacts of climate change.
Investing in a time of climate change – Jillian
Investors will be susceptible to climate risks in all forms – physical risks that disrupt businesses; transition risks demanding changes to industries, seeing some thrive and others disappear; liability risks as lawsuits for losses due to climate change, or breaches of fiduciary duty for inadequate assessment of these risks.
The Mercer climate scenario model
Mercer’s climate scenario model is based on projections of the future economy, incorporating various climate change risk factors and scenarios, which are then used to quantify the potential impacts on investment returns.
Four risk factors affecting investment are used: spending to transition to a lower-carbon economy; development of technology and policy to aid transition; impact of natural catastrophes; and availability of natural resources.
The 2°C, 3°C, and 4°C scenario pathways incorporate the physical changes at and transitions required to achieve these degrees of warming. The impacts of the risk factors on different asset classes and industry sectors are combined with the scenario pathways to determine investment outcomes.
Portfolio impact results
Return impacts on asset classes and industry sectors will vary between scenarios and geographic regions. However, for nearly all asset classes, regions, and timeframes, and on the total portfolio, overall returns are highest under the 2°C scenario. With lower temperature increases and less severe physical damage, investors suffer fewer losses. Those with exposure to the transition solutions also stand to benefit from a ‘low-carbon transition premium’ in this scenario as the market prices in climate-related impacts into investment assets.
Jillian noted that we would more likely see sudden rather than gradual impacts on returns.
Therefore, stress testing potential single-year return impacts where there is a sudden change in scenario probability and market awareness of climate change is an important exercise to understand how different portfolios are positioned for different ‘shock’ situations. These results suggest opportunities to benefit if we transform our economy for a 2°C scenario outcome over the next ten years, but it is all downhill from there if we do not.
What actions can investors take?
Jillian emphasised the importance of including climate change into an investor’s governance process, to be managed at the Board level. She further described four elements of investing in a time of climate change:
- Integrating climate risk into decision-making, through scenario analysis and portfolio carbon metrics, to understand impacts on investment return outlook;
- Engaging with companies and policymakers on climate-informed investment and transition to a low-carbon economy, making climate-related disclosures, and letting stakeholders know that climate risk is being managed;
- Investing in the transformation and adaptation solutions across asset classes to benefit from the potential return opportunities; and
- Screening out investments where climate-related financial risks are not able to be addressed through integration and engagement, or where stakeholders expected alignment with a well-below-2°C scenario outcome for ethical reasons.
Mercer’s report, co-authored by Jillian, can be found here.
Climate risk for life insurers and superannuation funds – Ramona
The session focused on physical and transition risks, but past lawsuits demonstrate the potential for liability risks to hit financial services.
Impacts on life insurance
Direct impacts on life insurers will come predominantly from physical risks. Australians can expect mortality and morbidity to increase, to varying extents by age and geography, from: weather-related events, subsequent mental health impacts for those affected, rise of vector-borne diseases, and worsening air quality.
Some of these are already coming to pass. Across Australia, unusually intense and numerous bushfires have arrived ahead of summer, causing losses of life and property in their immediate vicinity, and dangerously high levels of airborne particulate matter far away from the flames.
However, Ramona pointed out the difficulties in deriving estimated mortality and morbidity impacts of climate change, due to lack of data. Cause of hospital admission or claim is often recorded as the primary diagnosis, such as heart attack or stroke, but rarely captures the environmental trigger. Furthermore, mortality projections have been performed on an all-else-being-equal basis, but actual mortality will vary due to factors such as building standards, use of air conditioning, and public awareness.
Impacts on retirement incomes
An increasingly harsh environment will see people and organisations face disruptions in their daily lives and business. Individuals may face income risks that reduce their savings, including job losses and retraining, stopped work during business disruptions, or spending savings on repairs for climate-related damage. Furthermore, they are subject to return risk, or negative impacts on investment outcomes due to climate change.
Two scenarios were examined to understand the impacts of these risks: the first, a 10% reduction in lifetime employer super contributions; the second, a 1% decrease in returns, from ASIC’s default assumption for a Balanced portfolio of 4.8% p.a., to 3.8% p.a.
Assuming no changes to current government policy, including the age pension, accumulated superannuation savings drop 11% and 18% in Scenario 1 and Scenario 2 respectively. Total retirement income, defined as private superannuation draw-down plus any government-funded age pension, only drops by 2% and 5% in Scenario 1 and Scenario 2 respectively.
Decreases in retirement income are lower than decreases in superannuation balances, because eligibility for the age pension increases as superannuation balances drop, partially hedging these losses. This would be reflected in higher government costs to provide the age pension, estimated to be $20,000-$30,000 higher on average per person (net present value over the course of retirement, for the median earner, with no change in mortality).
Coverage of Ramona’s Dialogue paper can be found here.
Question time brought on further discussions, ranging from opportunities to improve climate impacts at various levels in the value chain, to the possibility of a sudden pricing in of climate risks into the market.
Modelling limitations were also discussed, with Jillian and Ramona acknowledging that changes in scenarios could easily change results, and aspects that they excluded in their models, including: interactions between and compounding of risks, feedback loops, and social implications. Notwithstanding such limitations, their analyses communicate the gravity of the current climate. On our current trajectory, we will see poorer investment returns, poorer mortality outcomes, and poorer retirees.
But by acting on climate change, there are opportunities to stop these becoming worse. And for stakeholders to whom, for various reasons, the moral, social, and environmental imperatives have thus far been insufficient to prompt action, now there is also the financial element to consider.
 See, eg, Emma Younger, ‘Commonwealth Bank faces legal action over failure to disclose climate change risk in report’, ABC News (online, 8 August 2017); Michael Slezak, ‘Super fund REST being sued for not having a plan for climate change’, ABC News (online, 25 July 2018).
 See, eg, Rachel McGhee and Jemima Burt, ‘Bushfire crisis costing Queensland and northern NSW millions’, ABC News (online, 22 November 2019); Sarah Thomas, ‘NSW bushfires destroy nearly 500 homes as crews scramble to build containment lines’, ABC News (online, 18 November 2019).
 See, eg, Luisa Rubbo and Kirstie Wellauer, ‘Waves of ash wash up on NSW beaches, Port Macquarie records world’s dirtiest air as bushfires burn’, ABC News (online, 15 November 2019); ‘Sydney air quality worse than Beijing as fires persist’, The World Today (ABC Radio, 19 November 2019).
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