Why better pensions help the climate – Bruno Bonizzi explains.

In October 2021, two UK-based academics, Dr Neil Davies and Dr Ewan McGaughey, issued proceedings against the directors of the University Superannuation Scheme (USS). The core claim was that the directors were not acting in the best interests of the scheme members, by using excessively pessimistic evaluations of the scheme’s accounts to justify deep pension cuts. This put collective pension guarantees at risk and as a result, the proposed cuts sparked repeated strikes in UK higher education. The legal case is still ongoing

Nowadays, struggles like this are rare in the UK, since collective schemes like USS are uncommon, covering only 7% of the active workforce. Instead, UK workers are automatically enrolled into “defined contribution” schemes. These are individual pension pots with no guarantees about pension outcomes. Pensions depend entirely on individual and employer contributions, and their financial markets performance. The individualisation of pensions is a broader global process, often justified on the basis of demographic trends and perceived unsustainable costs of collective pensions. To be sure, the burden on employers is reduced by lower contribution rates.

The flipside of individualisation is an erosion of pension security. A recent study by the Pension Policy Institute shows that poorer pension outcomes are more likely in defined contribution systems. This is not surprising, since these schemes expose individuals to economic and financial uncertainty. Retirement income depends on volatile market valuations, with no risk sharing with either their employers or other employees. 

The existing conflict over USS however goes beyond the protection of existing rights. As part of their legal claim, Davies and McGaughey argued that USS directors were failing to pursue members’ interests due to their continuing investment in fossil fuels companies. This is considered to be out of line with scheme members’ views, the Paris Agreement and USS’ own stated goal of reaching “net zero” by 2050. Large trade unions, such as Unison and UCU support divestment as a policy to fight climate change. 

Divestment from fossil fuels is a hot topic across pension funds.

Divestment from fossil fuels is a hot topic across pension funds. Most recently, the scheme for Dutch public sector and education workers, ABP – one of the largest schemes in the world – has stated its intention to fully divest from fossil fuel companies by 2023. However, these steps are quite radical in the UK context. A recent report found that none of the largest schemes had made a full commitment towards divestment and estimates that about £127 bn might be invested in fossil fuels. Divestment is also discouraged by pension minister Guy Opperman calling it “reverse greenwashing”. Instead, engagement with fossil-fuel companies is recommended, to encourage their transition to sustainability.

Even if divestment is desirable, the question is whether pension funds have the drive to do it. Research about European pensions shows that the answer depends on pension fund characteristics. Larger and public sector pension funds are more likely to divest; smaller company-based ones are much less likely to divest.

Even if divestment is desirable, the question is whether pension funds have the drive to do it.

The issue is that these are exactly the kind of schemes dominating in the UK. In the newer schemes, asset allocation is ultimately an individual choice. While so-called ethical options exist, most employees remain in the default fund, which includes non-green assets. This is in many ways inevitable. 

As Craig Berry shows in his recent book, despite the rhetoric about freedom and responsibility, the individualisation of pensions implies more risk aversion and conservative investments. After all, it is hard to see how a majority of individuals would make an active choice to divest from fossil fuels. This could expose them to risks they do not fully understand. Divestment requires a degree of risk sharing and engagement by pension scheme members. In other words, pension schemes need to be collective rather than individual arrangements.

It is hard to see how a majority of individuals would make an active choice to divest from fossil fuels.

Pension individualisation can therefore hinder or at least slow down the process of greening finance. It is no surprise that public-sector pension schemes are at the forefront of divestment in the UK. In the database of fossil fuel divestment, out of the 11 UK pension funds that have made a commitment to divest from fossil fuels, ten are public-sector funds[1]. Public-sector pensions retain a significant collective dimension. Pension rights are employer-guaranteed and investment decisions being made collectively, with union representation. 

The fight for better pensions and against climate change are in this sense related. Large, collective pensions better protect rights and result in better retirement. But they also create the conditions to accelerate divestment from fossil fuels. Protecting and promoting collective pensions, such as collective defined contribution schemes, should be a more central policy and political objective.

[1] The exception, the National Employment Savings Trust, is state-owned. It has only committed to divest from coal, oil sands and arctic drilling and be completely divested by 2025. Its remaining equity investments are in “climate-aware” strategies, which include oil and gas.

Bruno Bonizzi

Bruno is Senior Lecturer in Finance at Hertfordshire Business School. His research focuses on financial integration and financialisation, with reference to pension funds and emerging economies.

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