TSP Can Do More to Assess Financial Risk of Climate Change, Watchdog Finds

A federal watchdog agency last week reported that the federal government’s 401(k)-style retirement savings program should do more to assess the exposure of federal employees and retirees to climate change-related financial risk.

In a report commissioned by Sens. Maggie Hassan, D-N.H., and Jeff Merkley, D-Ore., the Government Accountability Office examined the Thrift Savings Plan’s approach to climate change, compared with other nations’ defined contribution retirement plans and other financial institutions. The watchdog concluded that although the TSP is more constrained legally than similar government retirement programs in how it manages participants’ investments, it still has some options at its disposal.

The Federal Retirement Thrift Investment Board conducts reviews of its investment policies every five years. The most recent review, conducted in 2017, concluded that that the TSP’s current offerings were adequate, and that no environmental, social and governance (ESG) funds were necessary.

But GAO noted that last year, the Federal Reserve warned that climate change risks “may not be adequately reflected in current asset prices,” and that financial risks related to climate change pervade much of the world economy.

“Of particular importance to retirement plans such as TSP that invest in passively managed broad market index funds, one data-analytics firm reported that as of November 2019 almost 60% of the companies in the S&P 500 index held assets that were at high risk of physical effects of climate change,” GAO wrote. “The data analytics firm also noted that S&P 500 companies face transition risks in the form of carbon pricing costs that would equal about 40% of their revenues under a moderate climate change forecast scenario.”

Physical climate change effects refer to risks associated with extreme weather like flooding and droughts, while transition risks are associated with policy changes to reduce the use of fossil fuels and other greenhouse gas emitters.

GAO acknowledged that, unlike retirement program administrators in the United Kingdom and Sweden, which can take active measures like proxy votes and “blacklisting” companies that do not conform to the Paris Climate Agreement to protect participants from climate-related financial risk, the TSP must be passively managed and tied to major market indexes. But the watchdog noted that the TSP’s board has been more active in the past when it comes to making changes to improve its offerings to participants, leading to the introduction of the S, I and L funds.

“FRTIB has previously taken steps to change TSP’s plan design to address investment risks revealed by prior reviews,” GAO wrote. “In the early 1990s, FRTIB reviewed its investment policies and, based on factors including diversification, risk and return, cost and industry practices, identified classes of assets that were missing from TSP’s investment mix. This led FRTIB to recommend adding two new funds—one for international stocks (the I Fund) and one for stocks in small- and medium-size U.S. companies (the S Fund).”

The next five-year assessment of the TSP’s offerings is slated for fiscal 2022. GAO urged TSP officials to look specifically at how the financial risks of climate change might impact participants’ savings.

“In managing the TSP, the FRTIB has not explicitly assessed the potential financial impact of climate change on the $700 billion in assets it manages for 6 million active and retired federal workers,” GAO wrote. “FRTIB is subject to requirements different than those for the plans we reviewed in other countries, which affect what actions it may take. However, FRTIB has a process to understand risks and has previously undertaken efforts to address risks. Including consideration of climate change as part of this process would provide FRTIB more complete information about potential risks relevant to its passive investment approach.”

In the agency’s response to GAO’s findings, TSP Executive Director Ravindra Deo highlighted comments from now-Treasury Secretary Janet Yellen citing the uncertainty of models aiming to assess climate change-related risk, and from Securities and Exchange Commissioner Hester Pierce criticizing the approach of ESG funds.

“The efficient market does recognize the downside risk of fossil fuel investment due to climate change,” Deo wrote. “However, while some firms will lose value due to climate change, others will gain; climate change does not necessarily portend universal downward risk.”

Deo also noted that the TSP plans to implement a mutual fund window in 2022, which will provide participants with the ability to invest a portion of their accounts in thousands of mutual funds, presumably including some that divest from fossil fuel companies and other polluters.