State Pension Funds and Climate Risk: A Roadmap for Navigating the Energy Transition

March 7, 2023

In the following brief,  authors Lenore Palladino, Jordan Haedtler, and Kristina Karlsson offer a full-throated rebuttal to the anti-ESG (environmental, social, and corporate governance) movement, arguing that in order to protect constituents’ future financial security, state officials must incorporate climate financial risk into their oversight and management of public pension funds.

Because climate change is such an enormous systemic risk, states that require climate risk disclosure and integrate climate risk assessments into state budgeting and investment practices will protect the economic beneficiaries of public pension funds: the public-sector workforce, both present and future.

Public pension funds are a cornerstone of the financial system. As of 2022, US state and local public pension funds—trusts that hold portfolios of financial assets meant to sustain retirees—comprised $4.5 trillion in assets and distributed $323 billion annually. Roughly 6,000 state and locally administered public pension funds provide retirement security for 11.2 million current retirees, in addition to 14.7 million future beneficiaries who are currently working—a combined total that is 14 percent of the US workforce (PPD 2022). Such funds are critical for the retirement security of the public-sector workforce and are sometimes analyzed solely from the perspective of financial returns. Yet if public pension funds do not proactively address the risks of climate change, it is those same public-sector workers—the current and future economic beneficiaries of pension funds—who will bear the burden.

In this issue brief, we explore how state and local public pension funds can be managed for the clean energy transition—and the risks that retirees will face if they are not. Facilitating an energy transition will require action from federal policymakers, and ensuring that that transition is orderly and minimally disruptive to the financial system will also require action from federal financial regulators. However, state and local policymakers have authority over their own public pension funds, and we focus here on mapping the path forward for this group of policymakers. We believe that large-scale, direct public investment is the best route to transform the economy for decarbonization (Mason 2022). Nevertheless, there are trillions of dollars in household financial assets held at the state and local levels that can be directed in ways that support or detract from the goal of decarbonization. For example, fund managers are divided over whether their portfolios should include holdings of fossil fuel companies. We argue that public pension funds, in serving the interests of their “economic beneficiaries” (the public-sector workforce), should be part of the energy transition—since public-sector workers, like all people, everywhere, have an interest in a livable planet and resilient economy. In fact, to ignore the climate risk inherent in holding fossil fuel equity jeopardizes the economic stability of workers’ capital. We propose several policy reforms for states to move public pension funds closer to meeting the interests of the public-sector workforce, including both current and future retirees.

Key Takeaways

It is crucial that policymakers at the state level develop—and advocate for—a framework that insulates their constituents from the financial and economic harms of climate change. They can do this by:

  1. Building on the new federal framework for ESG (environmental, social, and corporate governance) and climate risk disclosure standards;
  2. Revising and strengthening their conception of fiduciary obligations to expand the interpretations of beneficiaries’ “best interest”; and
  3. Materially embedding climate risk management and mitigation into their assessment of their investment portfolio and corresponding portfolio management decisions (including the important tool of proxy voting).