The Impact of the World on Member Outcomes: Moving Beyond Living Standards
Maximising member outcomes is one of the most commonly used phrases in the Defined Contribution pensions industry and it typically refers to maximising the amount of money an individual will have to survive on in retirement.
Why do we assume that member outcomes will be maximised by the amount of money an individual has in retirement? After all, money doesn’t buy happiness…
I am personally a long way from retirement but the state of the world by 2050 and beyond does worry me, in particular the physical impacts of climate change. While in the UK the impacts may be somewhat limited to warmer and wetter weather, elsewhere the physical impacts will be severe. Research conducted by the World Health Organisation showed that 3.6 billion people already live in areas highly susceptible to climate change1. Ultimately climate change will impact member outcomes in retirement.
Clearly individuals require a minimum amount of money in retirement in order to meet basic needs but beyond this surely the value an individual member places on the size of their pot at retirement is subjective?
Typically younger generations worry more about climate change and other socioeconomic issues than older generations. A study by Kings College London found that 66% of Gen Z and 57% of Millennials agree environmental concerns should take priority over economic growth, compared with 44% of Baby Boomers and 45% of Gen X.2 However, prioritising the environment or social good does not necessarily have to be at the expense of generating financial returns.
The concept of impact investing is not new; impact investing seeks to generate financial returns as well as creating positive social and/or environmental impact. For example, this may involve investing in companies that generate renewable energy or produce carbon capture and storage solutions.
Offering sustainable investment options may allow for a change in the way that pension schemes can interact with their members. There is increasing evidence that impact investing can improve members’ engagement levels, which in turn, may lead to higher contribution rates. A study by the Defined Contribution Investment Forum found that 50% of members would contribute more if their pension money was being used for sustainable investment3.
To date, the use of impact funds by DC schemes remains limited (particularly in the default investment option). Where DC schemes have made progress over the past 5 years is switching from market capitalisation equity indices to Environmental, Social and Governance (“ESG”) or climate transition indices. Mercer’s Responsible Investment Total Evaluation (RITE) showed that 60% of DC schemes now include some form of sustainable investment fund in their default investment option (as at September 2023).
The rise in the use of passive equity funds that seek to provide exposure to a range of sectors and companies that meet the chosen ESG criteria.is certainly a step in the right direction but they should not be seen as a single “catch-all” solution to addressing ESG issues including climate change.
As we move along the typical default investment option glide-path, currently there are few multi-asset and fixed income sustainable investment options available to DC schemes, although this is improving, particularly with the emergence of illiquid assets in DC.
Investment in illiquid assets by DC schemes (possibly through Long Term Asset Funds) opens up new opportunities that were previously confined to private markets. For example, there has been a fivefold increase in the number of climate technology start-ups since 2010, and total global investment in low-carbon energy technology passed US$1 trillion for the first time in 2022. 4
In summary, the range of sustainable investment tools available to DC schemes continues to evolve and presents the opportunity for members to invest in line with their priorities such as safeguarding the environment and promoting social good, while not necessarily sacrificing financial returns. Ultimately, climate change will increasingly impact member outcomes in retirement and sustainable investment tools have the potential to address members’ financial and non-financial goals.
Sources
1. Climate Change Newsroom – World Health Organisation 2023
2. Who Cares About Climate Change – Kings College London 2021
3. The Key to Unlocking Member Engagement – Defined Contribution Investment Forum 2020
4. State of Climate Tech analysis – PwC 2023
- Senior DC Investment Consultant