PRA PS25/25 and SS4/25 – Managing climate-related risks

PS25/25 and SS5/25 are relevant to all UK insurance and reinsurance firms and groups, including the Society of Lloyd’s and managing agents, banks, building societies and PRA-designated investment firms. The expectations do not apply to branches of overseas entities operating in the UK.

Proportionate application and materiality – the PRA has provided additional guidance:

• The expectations are intended to be applied in line with the materiality of each firm’s climate-related risk exposure, allowing for the development of tailored risk management solutions that best reflect its business operations.
• It may be appropriate for a firm to use less sophisticated approaches “provided these still enable appropriate risk management”.
• Firms should be able to demonstrate that their assessments of materiality are reasonable, proportionate and subject to appropriate governance.
• The PRA expects that firms’ materiality thresholds may evolve over time as climate science, data availability and modelling capabilities continue to advance.
• Supervisors will be able to request the evidence and rationale explaining how firms have identified material and immaterial risks, and the basis for any exclusions.

Climate scenario analysis (CSA) – firms will have flexibility to select the scenarios that best suit their risk profiles and the application of proportionality. The number and type of CSA exercises should be commensurate with a firm’s climate risk exposure.

Reverse stress testing – firms may choose whether to use reverse stress and/or scenario-based sensitivity analysis. Over longer-time horizons and for less likely scenarios, they will also be able to rely more on narrative, judgement-based scenarios and less on precise quantification.

Risk inventories – firms may integrate climate-related risks into existing risk registers or use supplementary sub-registers, if that approach supports robust risk identification. The PRA suggests an "accept, manage, avoid" approach, but this is not mandatory.

Data – the PRA has revised its expectation around data uncertainty from quantification to understanding. It has also confirmed that firms do not need to use conservative proxies where data or models are inadequate – instead, they are expected to select “appropriate proxies”, remaining aware of their limitations.

Recognition of litigation – given the evolving nature of climate-related litigation risk, firms will be able to apply judgement to categorise it in the way that best reflects their business and risk profile – in some cases this may include defining litigation risk as a distinct transmission channel.

Governance – firms may integrate climate-related responsibilities within existing governance frameworks rather than establishing new ones, providing their identification of risks remains robust. Relevant Senior Management (SMF) Function holders are expected to oversee climate risk management, but a new SMF specifically for climate risk is not required.

Nature – the focus of this policy is climate-related risk – the PRA has not set specific expectations on nature-related risk. It has however, emphasised that it expects firms to continue to manage all risks relevant to their business. It will continue to monitor nature-related risk and will update its position if needed.

• ICAAP/ILAAP: the PRA has confirmed that firms may align the climate scenario horizons used in ICAAPs and ILAAPs with standard timeframes for those processes. They may also wish to consider longer-term scenarios relevant for strategic and business planning to inform risk management.
• ICAAP: firms will be expected to be able to evidence how they have made judgements on risk materiality in their ICAAP, including for risks they deem immaterial, if asked by their supervisor. 
• ILAAP: the final policy has been updated to state that ILAAPs are only expected to consider stressed scenarios, rather than a central case, when firms are assessing their climate-related risks.
• Financial reporting: the PRA has acknowledged the challenges around data availability and maturity of firms’ climate risk capabilities for financial reporting. It has reiterated that the expectations are consistent with accounting standards and audit requirements and has aligned the wording more closely with the BCBS’s 2015 guidance on credit risk and accounting for credit losses.

• ORSA: the PRA has clarified that, even where they have short underwriting cycles, firms should include longer-horizon risks in their Own Risk and Solvency Assessments (ORSA) where these influence short-term decisions.
• SCR: existing SCR rules allow insurers to incorporate climate-related risks appropriately. The PRA has confirmed that firms are not expected to create a separate climate risk capital requirement, provided all quantifiable risks are captured.
• Standard formula: firms should address any significant deviations from standard formula assumptions, including climate risks, in their ORSA. If the formula is inadequate, a full or partial internal model may be required. In some case, this may be disproportionate, and the PRA may consider a capital add-on instead.
• Internal models: the PRA considers climate-related risks to be a risk driver in various components of the SCR. It recognises model limitations in respect of climate risk and notes that firms should continue to evolve their approaches as best practice develops.
• Matching adjustment (MA): for firms using MA, if ratings understate risks – including climate risks – the Fundamental Spread should be adjusted. Firms must not rely solely on credit ratings.