If pension funds and insurers remain heavily invested in high-carbon infrastructure… they face both physical risks… and transition risks

Hetal Patel is a UK based Chartered Actuary. He is Head of Sustainable Investment Research at Standard Life.

Praveen Gupta (PG): While investors increasingly recognise climate change as a financial risk, there are significant gaps in action and consistency, shows a recent report. Despite 75 per cent of investors incorporating climate risks into their strategies, many lack credible transition plans?

Hetal Patel (HP): Investors widely acknowledge climate change as a material financial risk, and many now reference it explicitly within their risk-management policies. In several jurisdictions, this is even a regulatory requirement, which has helped drive broad adoption of climate-risk frameworks.

However, far fewer investors have developed credible transition plans, and this is where the gap becomes clear. Transition plans remain voluntary and require a much deeper level of commitment than standard risk-management disclosures. They involve setting clear interim targets, providing transparent strategies for achieving them, and ensuring board-level accountability.

“Many investors recognise the risk but stop short of implementing the comprehensive measures needed for a credible transition"

From my perspective, several factors contribute to this shortfall. Investors face uncertainty about transition pathways, including evolving policy and technology landscapes. There is also concern about short-term underperformance relative to traditional benchmarks, which can discourage more ambitious climate-aligned actions. As a result, many investors recognise the risk but stop short of implementing the comprehensive measures needed for a credible transition.

PG: According to Prof. Narmin Nahidi of Exeter – Pension funds, insurance portfolios and long-term savings are heavily invested in companies, infrastructure and energy systems exposed to climate risk?

HP: Long-term savings vehicles are structurally exposed to climate risk because their investment horizons overlap with the period in which climate impacts will intensify. If pension funds and insurers remain heavily invested in high-carbon infrastructure and energy systems, they face both physical risks – like asset damage and disruption – and transition risks, such as policy tightening, carbon pricing, and technological shifts.

In managing this, I’d emphasise robust scenario analysis, stress-testing, and forward-looking risk assessment using climate metrics such as implied temperature scores. The goal is to align portfolios with a credible net-zero pathway, so beneficiaries’ long-term returns are protected rather than eroded by unmanaged climate shocks.

PG: Torsten Bell the UK Pensions minister has reportedly said: “Trust in Pensions it too low”. What drives such a perception and is it being suitably addressed?

HP: Low trust in pensions is driven by several long-standing issues. Many savers find the system complex and opaque, making it difficult to understand how their money is managed or what they can expect in retirement. High-profile concerns around fees, underperformance, and whether schemes act in savers’ best interests also undermine confidence. In addition, when people see their pension funds maintaining significant exposure to sectors that conflict with their values – such as heavy investment in fossil fuels -they question whether their savings are aligned with their long-term interests.

“Low trust in pensions is driven by several long-standing issues"

There are steps being taken to address this. Recent regulatory initiatives – such as the requirement for schemes to publish an annual investment governance report and enhanced climate-related disclosures – are improving transparency. These measures help create clearer communication, stronger accountability, and better insight into how trustees oversee investments and manage climate risks.

However, rebuilding trust requires more than compliance. Pension schemes, trustees, and providers need to demonstrate genuine conviction: showing how climate and other long-term risks are integrated into decision-making, how capital is being reallocated to support members’ future financial security, and how stewardship is being used to drive positive change. Only by making these actions visible and meaningful can the sector begin to restore public confidence.

PG: The way financial markets react to climate risks – are they responsive enough to extreme weather events becoming more frequent and environmental pressures intensifying? How well are they ensuring the economic security of savers?

HP: Markets are starting to price climate risk, but not fully or consistently. We see sharp reactions around major events or policy announcements, yet many climate risks are slow-burn, non-linear, and under-reflected in current valuations. That can create a danger that savers are exposed to sudden price shocks which can be a problem when pensions payments fall due.

Ensuring economic security for savers means not waiting for markets to catch up but to proactively adjust portfolios, diversifying away from vulnerable assets, and building resilience into long-term strategies. I would encourage the systematic integration of climate scenarios into risk models, more rigorous engagement with high-risk counterparties and clearer escalation when progress is insufficient.

PG: And how do you ensure that climate change is very much on the radars of trustees’ fiduciary duties?

HP: The starting point is to frame climate change explicitly as a material financial issue, not an ethical add-on. Fiduciary duty requires trustees to act in members’ best long-term interests, and climate risk is now inseparable from long-term financial outcomes. When trustees understand that climate factors directly affect asset values, volatility, and future liabilities, it becomes clear that addressing them is part of core fiduciary responsibility.

“Fiduciary duty requires trustees to act in members’ best long-term interests, and climate risk is now inseparable from long-term financial outcomes"

In the UK, trustees are supported by statutory guidance requiring them to identify, manage, and report on climate-related risks and opportunities. In practice, this means embedding climate considerations throughout governance and investment processes. Key steps include outlining the policy on climate risk into the Statement of Investment Principles, ensuring regular board training on climate and transition risks, incorporating climate metrics and scenario analysis into Task Force on Climate-related Financial Disclosures (TCFD) reporting, and making climate a standing agenda item at trustee meetings.

I also see strong stewardship policies as essential. Clear expectations on voting, engagement, and escalation – including when divestment is appropriate – help trustees demonstrate that they are actively managing climate risk rather than simply acknowledging it. Taken together, these measures ensure climate change is treated as a central component of fiduciary duty and not something peripheral.

PG: Are environment, societal and governance (ESG) factors well embedded at the governance level and diligently adhered to?

HP: ESG is often present in policy documents, but the real test is whether it shapes decisions. I’d look to capture ESG – especially climate – into board competencies, risk frameworks, and remuneration structures. For example, linking part of executive pay to climate outcomes.

When governance structures and incentives are aligned, adherence becomes much more consistent and credible.

PG: How seriously do you see fossil fuel as stranded assets in the near term?

HP: In the long term, there is a genuine risk that certain fossil-fuel assets become stranded, particularly high-cost or long-lived projects that rely on demand, policy, or price assumptions that may not hold. As climate policy tightens, low-carbon technologies scale, and investor expectations shift, some reserves and infrastructure may never be fully exploited or may lose value far more quickly than anticipated.

That said, this does not imply an immediate or wholesale exit from all fossil-fuel exposure. In periods of geopolitical tension – such as the current environment – oil and gas prices can spike, and fossil-fuel companies may outperform in the short run. The key is to be highly selective and forward-looking, rather than assuming past performance will continue.

“I would prioritise rigorous assessment of assets under stringent climate scenarios…"

From a portfolio perspective, I would prioritise rigorous assessment of assets under stringent climate scenarios, reducing exposure to the segments most vulnerable to transition risk, and reallocating capital toward transition-aligned opportunities such as renewables, grid infrastructure, energy efficiency, and broader climate solutions. This helps ensure we are not left holding assets that cannot deliver an adequate risk-adjusted return as the global energy system evolves.

PG: Is the UK market witnessing law suits against pension funds for not addressing Climate Change adequately?

HP: Not yet in any significant volume. In the UK, we haven’t seen major lawsuits directly targeting pension funds for failing to manage climate risk, but the pressure is clearly rising. Regulators, campaign groups, and members are increasingly scrutinising whether trustees are meeting their fiduciary duties in a climate-aware way.

Globally, however, litigation is already happening. The McVeigh v. REST case in Australia is a well-known example, where a pension fund agreed to strengthen its climate-risk management after being challenged by a member. This and other international cases are shaping expectations in the UK.

Combined with mandatory climate reporting for larger schemes, they signal that trustees who fail to act on climate risk could face legal challenges in the future, even if the UK hasn’t seen them at scale yet.

PG: It was wonderful listening to you at the recent Global Conference of Actuaries (GCA). Many thanks for these excellent and candid insights.