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Senate Bill 22-138, which would require private insurers and the Colorado Public Employees Retirement Association (PERA) to assess climate-related risks to their portfolios and publish annual reports, is right on time for a changing investment world. Requiring regular climate risk assessments from PERA is an important first step for the Colorado General Assembly to fulfill its fiduciary duties regarding climate risk.

The bill recognizes that our changing climate is no longer just an environmental or social issue to be addressed in the future. It is also a financial issue that introduces systemic risk to global markets and imposes new financial costs each year. Increasingly frequent extreme weather patterns—heat waves, droughts, wildfires, and floods—threaten property losses and ruined communities. Certain sections of the economy and society are particularly hard hit. As society mitigates and adapts to climate change, some sectors of the economy will lose.

The bill lists several risks for the reports to address, such as extreme weather events and a growing disease burden. Investment risks from climate change also stem from changes in the economy and financial markets as businesses, investors, and governments respond to the effects of climate change.

The key economic sector facing this type of risk is the energy sector, especially the fossil fuel industries. Fossil fuel industries have underperformed the market for the last 10 years. They face a negative long-term outlook as the economy decarbonizes.

  • Fossil fuels face limited growth opportunities due to increasing competition from alternative technologies in the electricity and transportation markets, and stricter environmental and public health regulations.
  • The sector’s revenue is volatile due to its dependence on commodity prices. Both low and high prices create challenges: Low prices undercut the industry’s long-term financial returns, while high prices impose costs across the global economy and funnel profits to petrostate autocrats, reinforcing the urgency to reduce consumption of fossil fuels.
  • The sector has broadly failed to present a credible plan to adapt to a low-carbon economy, dampening demand for the sector’s securities and forcing investors to spend additional time and effort distinguishing the risk profiles of individual companies.

In view of these risks, farsighted leaders in the insurance industry are already repositioning their investments and business lines. Many large European insurers and reinsurers have excluded investments in the fossil fuel industry, and some now refuse to underwrite insurance policies for the industry’s operations. Companies such as The Hartford and Axis Capital have been among the first insurers in North American to follow suit. Requiring insurers in Colorado to assess their climate risks is a commonsense measure that reflects the best practices of global insurance firms.

Regarding PERA, state law charges the organization with the management of public investment funds that serve the needs of state and local workers and retirees, teachers, and judges. The fund’s value stood at $62 billion last September. Disbursements from the fund reach beneficiaries in every county in the state. These payments make important contributions to the economies of the state’s rural communities.

Public pension funds in other states have already taken action to mitigate the risks facing the fossil fuel industry. They have done so primarily by divesting their portfolio from the industry’s securities. Such actions began in many cases with a climate-risk assessment. The General Assembly and the PERA board will eventually need to determine whether PERA can divest fossil fuels from its portfolio in a manner that is consistent with its investment targets. Many other public and private investment funds have asked and answered that question in the affirmative, and we are witnessing more and larger funds taking constructive action to combat climate change.

Meanwhile, a climate risk assessment of the pension fund benefits several key constituencies. It would allow pensioners and other interested parties to develop a better understanding of the funds’ solvency for the purposes of meeting their investment targets.

For policymakers, PERA’s annual returns, funded ratio, and the long-term outlook each play an important role in determining the state’s direct contribution to PERA. If fund managers miss their financial targets, there are budget consequences that can lead to higher public expenditures. This is a poorly understood issue. Weak financial performers in investment funds like the fossil fuel sector have fiscal consequences for the state.

Clear-eyed climate risk assessments will enable informed and intelligent discussion about state investment policy and the consistency of its policies with other areas of the public interest, such as the environment and public safety. Senate Bill 22-138 reflects an open-minded approach to the issues of climate risk and will put the ensuing dialogue about how to mitigate these risks on solid footing.

 

Dan Cohn ([email protected]) is an IEEFA global energy transition researcher.

 

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Dan Cohn

Dan Cohn is Global Energy Transition Researcher at IEEFA. His research focuses on protecting institutional investment funds from the volatility associated with global commodity prices and the fossil fuel industry.

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