The European Insurance and Occupational Pensions Authority (EIOPA) has published the results of its first climate stress test for Institutions for Occupational Retirement Provisions (IORP), highlighting that schemes are “materially exposed” to green transition risks.

The stress test aimed to assess the resilience of IORPs against a climate change scenario that simulates a sudden, disorderly transition to a green economy due to the delayed implementation of policy measures.

On aggregate, more than 65 per cent of assets in defined benefit and defined contribution schemes in the European Economic Area were analysed.

It found that the transition scenario would result in a “sizeable drop” in asset values of 12.9 per cent, equating to losses of around €255bn.

The bulk of the drop in asset value showed up in equity and bond investments.

On average, IORPs have around 6 per cent of their equity and 10 per cent of their corporate bond investments in carbon intensive industries, such as mining and gas.

For these carbon intensive investments, the scenario predicted losses of between 20 per cent and 38 per cent.

The scenario, which included interest rate movements, also affected liabilities.

Due to the scenario’s rise in risk-free, liabilities decreased, which helped offset the impact of the devaluation in assets on the funding ratio, although not fully.

Financial positions therefore still worsened slightly, with funding ratios declining by 2.5 percentage points to 120.2 per cent according to the national methodology and by 2.9 percentage points to 117 per cent according to the common methodology.

However, aggregate funding ratios in defined benefit schemes remained above the 110 per cent in most member states, which EIOPA said was in part due to strong pre-shock positions.

“When looking at both assets and liabilities, the impact on funding ratios appears manageable, which in itself is reassuring,” commented EIOPA chair, Petra Hielkema said.

“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 IORPs.”

The stress test found that although IORPs were increasingly considering ESG factors in their investment decisions, they still experienced hurdles in allocating investments to climate risk-sensitive categories.

Just 14 per cent of IORPs reported using environmental stress testing in their own risk management, with those doing so performing better in the exercise than those who were not using environmental stress testing.

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