E.U. plans face $270 billion in losses under disorderly climate transition − EIOPA

European retirement plans are "materially exposed to transition risks," with potential losses of €255 billion ($268.5 billion) under a disorderly transition to a green economy, the region's first stress test shows.

The European Insurance and Occupational Pensions Authority conducted a climate stress test of 187 defined benefit funds and defined contribution plans from 18 European Economic Area countries, representing €1.98 trillion in assets and 65.3% of total EEA retirement plan assets. The authority looked at a climate change scenario that "simulates a sudden, disorderly transition to a green economy as a consequence of the delayed implementation of policy measures," EIOPA said in a report of its findings.

EIOPA considered both the asset and liability side of plan portfolios and applied two methodologies: a national balance sheet approach, based on national valuation regulation; and a common balance sheet approach, using mark-to-market valuations.

On the asset side, the stress scenario showed a 12.9%, or €255 billion, drop in valuations, with the majority of losses in equity and bond exposures. The authority said European plans on average had about 6% of equity investments and 10% of corporate bond exposures in carbon-intensive industries, such as mining, electricity and gas, and land transport.

An about 11% drop in DB fund liabilities was more than offset by the fall in assets, leading to a decrease in funding ratios, EIOPA said.

Funding ratios decreased by 2.5 percentage points on a national balance sheet assessment to 120.2%, and by 2.9 percentage points using the common methodology, to 117%. EIOPA said the funding ratios remained above 100% due, in part, to "strong pre-shock positions."

"When looking at both assets and liabilities, the impact on funding ratios appears manageable, which in itself is reassuring," Petra Hielkema, chairwoman of EIOPA, said in a statement accompanying the report. "Nevertheless, the heavy losses on the asset side clearly showcase the sector's vulnerability to climate risks, especially regarding investments in carbon-intensive industries. In this year's scenario, a drop in liabilities due to rising interest rates helped counterbalance much of the asset-side losses, but this may not be the case in every scenario. It's important to reflect on this and consider testing different scenarios in future exercises as they might give us even better insights into the environmental risks borne" by European retirement plans, she said.

EIOPA also conducted a qualitative survey on mitigation and adaptation measures taken by retirement plans, which found ESG factors are increasingly under consideration. Just 14% of plans said they use environmental stress testing in their own risk management. However, EIOPA found that this portion of plans performed better in the stress testing exercise than their peers that do not conduct such analysis.

The stress test scenario was developed with the European Systemic Risk Board and the European Central Bank.