European pension investment institutions have “material exposure” to climate risks, according to stress test results released today by the European Insurance and Occupational Pensions Authority (EIOPA), the EU’s insurance and pension-focused financial regulator.

Launched in April, EIOPA’s first climate stress test was designed to assess the resilience of European institutions for occupational retirement provision (IORPs) to a scenario of sudden, disorderly transition to climate neutrality due to delayed policy action.

The scenario envisioned a sharp increase in carbon prices, leading to a strong increase in fossil fuel prices, raising energy costs, impacting the general economic outlook, and pressuring equity markets, particularly in carbon intensive sectors. Other effects anticipated by the scenario included rising corporate credit spreads for brown industries, rising yields increasing the cost of issuing sovereign debt, and a slowdown in the value growth of tangible asset classes, such as real estate.

The exercise, focused on the asset portfolio of the IORPs, found that the scenario generated a nearly 13% drop in assets, corresponding to €255 billion in losses, primarily in equity and bond investments. On average, the IORPs were found to have 6% of their equity and 10% of their corporate bond investments in carbon intensive sectors including mining, electricity & gas and land transport, which saw write-downs of between 20% – 38%.

Overall, while the impact on funding ratios appeared manageable, with the asset valuation declines somewhat offset by liability-side decreases from higher risk-free rates, the regulator said that this did not fully offset the drop.

A survey conducted alongside the stress test found that only 14% or IORPs use environmental stress tests in their own risk management, while those that do carry out these tests tended to perform better in the exercise than their peers.

EIOPA Chair Petra Hielkema said:

“When looking at both assets and liabilities, the impact on funding ratios appears manageable, which in itself is reassuring. Nevertheless, the heavy losses on the asset side clearly showcase the sector’s vulnerability to climate risks, especially regarding investments in carbon-intensive industries.”

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