PS25/25 – Enhancing banks’ and insurers’ approaches to managing climate-related risks – Update to SS3/19

1: Overview

1.1 This Prudential Regulation Authority (PRA) policy statement (PS) provides feedback to responses the PRA received to consultation paper (CP) 10/25 – Enhancing banks’ and insurers’ approaches to managing climate-related risks – Update to SS3/19. It also contains the PRA’s final policy, as follows: Supervisory statement (SS) 4/25 – Enhancing banks' and insurers' approaches to managing climate-related risks (Appendix 2).

1.2 This PS marks another step in the PRA’s work to support the enhancement and maturation of banks’ and insurers’ (‘firms’) approaches to managing climate-related risks. The final policy detailed in SS4/25 is intended to promote effective risk assessment and risk management capabilities. It aims to help firms build resilience against climate-related risks and make informed strategic decisions that support their business interests, including through the provision of appropriate financial products that can promote sustainable economic growth. The approach is proportionate, practical, and reflects the evolving climate-related risk landscape.

1.3 The final policy builds on the PRA’s 2019 expectations for firms’ management of climate-related risks, by providing greater clarity and detail as requested by firms in scope, and to bring the expectations up to date with international standards and developments in the understanding of climate-related risks since 2019. The update has been shaped through extensive engagement with industry and stakeholders, and the PRA welcomes the valuable and constructive feedback received during the consultation process.

1.4 The approach recognises that the impact of climate-related risks on the safety and soundness of a firm is likely to be driven by factors other than firm size, such as business model and geographical exposure. Accordingly, the final policy is designed to be implemented proportionately by firms in line with the materiality of a firm’s climate-related risk exposure, allowing firms to tailor their actions and develop risk management solutions that best reflect their business operations without additional undue burden. However, where a small firm has assessed that its business has a material exposure to climate-related risks, it may still choose to tailor its response accordingly. For example, it may use less sophisticated approaches, provided these still enable appropriate risk management.

1.5 Responses to CP10/25 reflected a range of views, but the overall sentiment was supportive, and none challenged the case for regulatory action (see Chapter 2: Feedback to responses). In response to feedback on CP10/25, the PRA has made some changes to the final policy in several areas, including the proportionate application of the expectations and the role and application of scenario analysis and reverse stress testing.

1.6 The PRA recognises that practices are evolving in this area and that implementation of the final policy will require ongoing effort and collaboration across industry groups to collectively develop and advance best practice. To support firms, the PRA will continue to engage with, and support, industry groups in developing further guidance and case studies. Specifically, the PRA intends to invite the Climate Financial Risk Forum (CFRF) to update, consolidate and evolve its guidance and tools over time to reflect, and support firms in meeting, the PRA’s updated supervisory expectations. The PRA also encourages firms to continue engaging with their supervisors to ensure that their approach to managing climate-related risks remains proportionate and effective as the risk landscape evolves.

Scope

1.7 This PS is relevant to all UK insurance and reinsurance firms and groups, ie those within the scope of Solvency II including the Society of Lloyd’s and managing agents (‘Solvency II firms’) and non-Solvency II firms (collectively referred to as ‘insurers’), banks, building societies, and PRA-designated investment firms (collectively referred to as ‘banks’). ‘Firms’ is used in this PS to refer to both insurers and banks. The proposed expectations set out below do not apply to branches of overseas entities operating in the UK. Accordingly, the scope remains the same for PRA-supervised firms as under SS3/19.

Background

1.8 The increasing frequency and severity of climate events – such as flooding, extreme heat, and rising sea levels – pose growing threats to financial institutions. Climate-related risks are not only physical but also potentially transitional, as the economy adapts to decarbonisation. The financial sector is already experiencing the effects of climate change through direct losses and shifts in business models. As governments and markets respond to climate change, firms must navigate complex changes in asset valuations, customer behaviours, and regulatory landscapes.

1.9 While some firms have made progress in developing climate risk capabilities since the PRA’s initial expectations were set in 2019, progress remains uneven. Understanding and effective risk management of climate-related risks remains challenging and continues to evolve. The PRA’s updated expectations respond to industry calls for greater clarity and consistency, supporting firms as they build their resilience against climate-related risks.

1.10 In CP10/25, the PRA proposed to:

• Strengthen governance arrangements (Chapter 1) by ensuring that firms’ boards and senior management are actively engaged in overseeing climate-related risks. This includes embedding climate considerations into strategic decision-making and ensuring accountability for climate oversight.
• Enhance risk management frameworks (Chapter 2) to ensure that climate-related risks are integrated across all relevant risk types. Firms are expected to adopt robust, transparent methodologies and assumptions, with appropriate oversight, to assess and manage these risks proportionately to their business models and exposures.
• Advance the use of climate scenario analysis (Chapter 3) by requiring firms to demonstrate a strong understanding of how scenario outputs inform business decisions. The PRA emphasised the need for firms to move beyond compliance and use climate scenario analysis (CSA) as a strategic tool to assess resilience under different climate pathways.
• Improve the quality and usage of climate-related data (Chapter 4), recognising that effective risk management depends on reliable, granular and forward-looking data. Specifically, that firms should critically assess data sources and address gaps in coverage and quality to support decision-making.
• Maintain expectations around disclosures (Chapter 5), encouraging firms to provide transparent, decision-useful information to stakeholders. This includes aligning disclosures with evolving international standards and ensuring consistency in reporting climate-related risks and opportunities.
• Outline banking-specific expectations (Chapter 6), including the integration of climate-related risks into the Internal Capital Adequacy Assessment Process (ICAAP) and the Internal Liquidity Adequacy Assessment Process (ILAAP). The PRA also proposed that banks should have appropriate processes in place to ensure timely capture of climate-related risks for financial reporting purposes, subject to effective governance.
• Set out insurance-specific expectations (Chapter 7), including incorporating climate-related risks into the Own Risk and Solvency Assessment (ORSA) and stress testing frameworks. The PRA also addressed the need for insurers to consider long-term trends in mortality, morbidity and public health, particularly for life and health insurers.
• Replace SS3/19 in its entirety at the time of publication of the new SS. Following publication of the final policy, firms would be expected to conduct an internal review of their current status in meeting the expectations set out in the final policy, and to develop plans for addressing these gaps. To allow firms time to transition to the updated expectations, the PRA proposed that supervisors would not ask firms to evidence their internal assessments or action plans until at least six months after the publication date.
• Provide guidance on the proportionate application of the expectations by firms.

1.11 In determining its final policy, the PRA has considered the responses to the consultation. This PS sets out an account of the responses and the PRA’s feedback to them. In this PS, the ‘Summary of responses’ section contains a general account of the representations made in response to CP10/25 and the ‘Feedback to responses’ chapter contains the PRA’s feedback.

1.12 In carrying out its policymaking functions, the PRA is required to have regard to various matters. In CP10/25, the PRA explained how it had regard to the most relevant of these matters in relation to the proposed policy.

Summary of responses

1.13 The PRA received 59 responses to CP10/25. The names of respondents who consented to their names being published are set out in Appendix 1.

1.14 Respondents generally welcomed the PRA’s approach to update its supervisory expectations and supported the direction of the proposed policy set out in CP10/25, with no material objections raised. Respondents recognised the value of greater clarity in the proposed policy and viewed CP10/25 as a pragmatic and constructive step in the evolution of climate risk management practices. Respondents also made a number of observations and requests for clarification on several aspects, which are set out in Chapter 2: Feedback to responses.

1.15 A key theme from the responses was a request for a clearer distinction between PRA expectations and illustrative guidance. Firms appreciated the PRA’s proportionate and flexible approach but requested further clarity on how to apply the expectations in practice – particularly for smaller firms. Respondents also raised questions about governance, including the need for flexibility in board-level delegation and the integration of climate risk into broader risk appetite frameworks.

1.16 Implementation was a recurring theme, with firms seeking clarification on timelines, citing data limitations, modelling complexities (eg related to climate scenario analysis), and potentially underestimated costs. The PRA has considered these points in finalising the proposed policy and will continue to engage with firms to support effective implementation.

Changes to draft policy

1.17 This policy statement sets out the PRA’s feedback to the responses. The main changes to the supervisory statement are:

• Clarification of proportionate application of expectations by firms: The PRA has introduced an additional ‘Overarching aims’ section to the ‘Proportionate application of expectations’ sub-section of Chapter 3: Implementation. This explains the policy intent behind the expectations, particularly regarding how firms should determine how a proportionate application of the final policy reflects their level of exposure to material climate-related risks, as well as the size and complexity of their business. It also notes the important role of the Climate Financial Risk Forum (CFRF) in supporting implementation of the expectations through guidance and case studies.
• Recognition of litigation risk: The PRA has decided that given the evolving nature of climate-related litigation risk, firms can apply judgement to categorise it in the way that best reflects their business and risk profile, and that in some cases this may include defining litigation risk as a distinct transmission channel.
• Clarification of review period: With respect to the six-month review period proposed in CP10/25, the PRA has clarified that this is not an implementation timeline, but a period during which firms would be expected to conduct an internal review of their current status in meeting the expectations set out in the final policy. As part of this internal review, firms should identify the expectations that require further work for them to meet and develop a credible and ambitious plan for how they will address any gaps. Supervisors would not ask for evidence of firms’ internal reviews and action plans until at least after the end of the six-month review period.
• Cost-benefit analysis (CBA): The PRA has clarified the core assumptions underpinning its CBA. Specifically, the cost estimates reflect the incremental costs associated with implementing the updated expectations, rather than costs of meeting the expectations that were already in place.
• Governance: In light of responses from firms, the PRA has confirmed that firms may integrate climate-related responsibilities within existing governance frameworks rather than establishing new ones, if risk identification remains robust.
• Risk management: The PRA has clarified that firms may integrate climate-related risks into existing risk registers or use supplementary sub-registers, if that approach supports robust risk identification. The PRA also confirms that the ‘accept, manage, avoid’ language in the final policy is a suggestion, rather than an expected format. Other minor edits have been made in relation to the proposed Operational Resilience expectations, to align them with SS1/21 – Operational resilience: Impact tolerances for important business services.
• Climate scenario analysis: In line with the flexibility for firms to select scenarios that best suit their risk profiles and the application of proportionality, the PRA has clarified that the number and type of CSA exercises should be commensurate with the firm’s climate risk exposure. The PRA has also made a small change that firms can choose whether to use reverse stress and/or scenario-based sensitivity analysis and that analysis over longer-time horizons can rely more on narrative scenarios and less on precise quantification.
• Data: The PRA has made two changes to the final policy following responses from firms. The first reduces the expectation for firms to ‘quantify’ data uncertainty to an expectation for firms to understand it. The second is that firms do not need to use conservative proxies where data or models are inadequate; instead, they should select appropriate proxies and remain aware of their limitations.
• Banking-specific expectations: The PRA has confirmed that firms may align climate scenario horizons used in ICAAPs and ILAAPs with standard timeframes for those processes, while also considering longer-term scenarios for strategic planning. On financial reporting, the PRA has acknowledged challenges around data availability and maturity of firms’ climate risk capabilities. However, it has reaffirmed that its expectations remain consistent with accounting standards and audit requirements.
• Insurance-specific expectations: The PRA has clarified that the existing SCR Rules provide sufficient flexibility for an insurer to take account of climate-related risks in a way that it considers appropriate. For internal models, the PRA considers climate-related risks to be a risk driver in various components of the SCR. On credit ratings for the regulatory balance sheet, the PRA has clarified that where a firm considers that a CRA does not make sufficient allowance for risks when issuing a credit rating, including climate-related risks, it may make an appropriate adjustment. For market prices of climate-related risks, the PRA has clarified that if a firm considers these risks to be underpriced, it may reflect this in its ORSA and SCR.

1.18 Given the mostly clarificatory nature of the changes, the PRA considers that these amendments will not place any additional burden on firms beyond those set out in CP10/25. Instead, it may reduce the potential burden for many, by further emphasising the proportionate application of the expectations by firms. Other than the above changes, some immaterial amendments were made to correct anomalies, consistency in terminology and application scope to help improve clarity.

1.19 In carrying out its policymaking functions, the PRA is required to have regard to several matters. In section 5 of CP10/25 (ie the Have Regard analysis section), the PRA explained how it had regard to the most relevant of these matters in relation to the proposed policy. The analysis, as presented in CP10/25, remains unchanged following the consultation responses. This PS also takes account of how the policy advances the PRA’s objectives, which also remains unchanged.

Implementation and next steps

1.20 The final policy replaces SS3/19 in its entirety and takes effect on the date of publication of this PS on 3 December 2025.

2: Feedback to responses

2.1 The PRA must consider representations that are made to it in accordance with its duty to consult on its general policies and practices and must publish, in such manner as it thinks fit, responses to the representations.

2.2 The PRA has considered the representations received in response to CP10/25. This chapter sets out the PRA’s feedback to those responses, and its final decisions.

2.3 The sections below have been structured broadly along the same lines as the chapters of CP10/25, with some topics grouped to better respond to related issues. The responses have been grouped as follows:

• Scope and PRA objectives
• Implementation:
  • Review period
  • Proportionate application of expectations by firms
  • Cost-benefit analysis
• Supervisory expectations:
  • Governance
  • Risk management
  • Climate scenario analysis
  • Data
  • Disclosures
  • Banking-specific issues
  • Insurance-specific issues

Scope and PRA objectives

2.4 The PRA received 16 responses on the exclusion of nature risk from its proposed policy. The PRA notes that the policy is focused on climate-related risk and the PRA has not set specific expectations on nature-related risks. However, the PRA continues to expect firms to manage all relevant financial risks to which they are exposed. The PRA continues to monitor and assess all sources of risk and may update its position if needed.

2.5 The PRA also received 20 responses commenting that the proposed policy did not sufficiently address the concept of double materiality (i.e. that firms should assess not only how climate-related risks impact their own financial position, but also how their own activities contribute to climate outcomes). These respondents argued that the proposed policy treats climate change predominantly as an external risk to be managed, without sufficiently acknowledging the financial sector’s role in driving or mitigating climate-related risks.

2.6 The PRA acknowledges the breadth of perspectives on double materiality and the role of financial institutions in supporting the transition to a net-zero economy. As noted in paragraph 1.5 of the final policy, the PRA’s supervisory expectations are grounded in the PRA’s primary objectives to promote the safety and soundness of the firms it regulates and secure an appropriate degree of protection for insurance policyholders. As the UK’s prudential regulator, it is the PRA’s role to ensure that UK firms can manage the operational and financial risks associated with climate change and transition.

Implementation

Review period

2.7 The PRA received 13 responses related to its proposed policy for a six-month review period in CP10/25.

2.8 One respondent asked about the rationale for the final policy coming into force on its publication day. The PRA can confirm that the final policy builds on and replaces SS3/19 in its entirety and therefore takes effect on the date of publication alongside this PS on 3 December 2025.

2.9 The majority of respondents asked for more clarity on the proposed six-month review period referred to in CP10/25. Specifically, respondents queried whether firms would be expected to have closed all identified gaps by the end of that review period, or whether their focus for the six months should be on undertaking a gap analysis against the expectations set out in the final policy and to develop a plan for addressing any gaps identified. Respondents stressed that closing all identified gaps within six months of the final policy being published would be difficult, with several respondents asking for an extension of the period from six to twelve months.

2.10 The PRA confirms that firms will be expected to carry out an internal review of their current status in meeting the expectations set out in the final policy and develop a plan for addressing any identified gaps. This should be completed within six months of commencement of the final policy. The PRA does not expect firms to close identified gaps within this six-month review period. Supervisors may ask for evidence of firms’ internal reviews and action plans but would not do so until at least after the six-month review period has ended. Consistent with its message in previous publications,^{footnote [1]} the PRA expects firms to take a forward-looking, strategic and ambitious approach to managing climate-related financial risk on an ongoing basis. SS4/25 has been updated to reflect these clarifications in paragraphs 3.1–3.5.

2.11 One respondent queried whether firms would be expected to undertake an interim annual refresh of their SCR, ILAAP or ICAAP calculations within the six-month period in order to take into account the new SS. The PRA clarifies that this is not the case, and that firms can schedule any necessary model updates after they have completed their gap analysis as per their usual timetable.

2.12 Finally, the PRA encourages firms to leverage initiatives such as those led by the CFRF as they work through their implementation plans.

Proportionate application of expectations

Approach

2.13 The PRA received 22 responses related to the proportionate application of the supervisory expectations. Several respondents welcomed the PRA’s continuation of a principles-based approach, favouring it over more prescriptive and less flexible rules. Several respondents also emphasised the importance of proportionality, particularly for smaller firms or firms with limited exposure to climate-related risks, and requested that the expectations be appropriately scaled to reflect the nature and size of risk profiles.

2.14 A common theme in the responses was the request for greater clarity on how firms should proportionately apply the expectations in practice. Twelve responses were concerned that some expectations in the proposed policy could be perceived as being prescriptive and may not be applicable to all business models. Respondents suggested clear signposting of the minimum actions required to meet PRA expectations. Several respondents also called for case studies and illustrative examples to support firms’ understanding of the proportionate application of the proposed policy.

2.15 To support clearer understanding of the policy intent, particularly with regards to the application of proportionality by firms, the PRA has added new sections to Chapter 3 of the final policy, which cover the overarching considerations for the application of expectations (paragraphs 3.6–3.13 of the final policy). These clarify the intent of the proposals, specifically that:

• The aim of the final policy is to promote effective risk management practices in relation to climate-related risks. It is in the interest of firms to ensure robust assessment and monitoring of climate-related risks, in a way that is proportionate to their risk exposure, in line with the approach they take for other risks.
• The PRA recognises that the impact of climate-related risks depends on several factors beyond firm size, in particular, the firm’s business model and the geographical concentration of its balance sheet.

It also makes one change to the policy:

• Where a small firm has assessed that its business has a material exposure to climate-related risks, it is expected to take action commensurate to the level of risk – just as it would for other risks of similar materiality. However, such small firms may still choose to use less sophisticated tools and approaches than larger, more complex firms. In this case, firms should understand the limitations of the tools they select and apply a prudent interpretation of the information produced when informing decision-making.

2.16 The final policy does not include additional case studies or examples of proportionate application. Such examples could rapidly become outdated. The PRA recognises that best practice in managing climate-related risks, including choices of the most suitable solutions to apply, will vary by firm and circumstance. Best practice will also evolve over time as climate risk science, government policy, disclosure requirements, customer behaviour, and the availability, quality and cost of climate-related data, models and consultancy services develop.

2.17 The PRA decided not to set minimum expectations as this would be contrary to the principles-based approach, which allows firms to scale their response to reflect the climate-related risks they face. A more prescriptive approach, such as this, would reduce firms’ flexibility to apply the approach according to their own risk assessment and specific circumstances.

2.18 The PRA will engage with the CFRF to support the implementation of the expectations by updating existing supporting materials and documentation, or through additional guidance and case studies. A new clarificatory section on the role of the CFRF in supporting the implementation of the expectations has been added to paragraphs 3.26–3.28 of the final policy.

Definition of materiality

2.19 Related to the issue of proportionality, 18 respondents also commented on the definition of ‘materiality’. Many requested guidance on how to apply materiality thresholds, especially for smaller firms. Others requested that materiality and proportionality thresholds should be left to firms’ judgement to determine. Many also emphasised the importance of allowing firms to integrate climate-related risks into existing risk management frameworks, rather than treating them as distinct categories.

2.20 Some of these respondents expressed concern that the final policy could result in excessive compliance burdens, particularly if materiality thresholds are interpreted too narrowly or require extensive quantitative analysis. There was a strong call for clarification of how immaterial risks should be treated, including the level of documentation needed to justify such assessments.

2.21 The PRA considers that firms should apply judgement in assessing the materiality of such risks, taking into account their business models, risk appetites, and broader risk exposures. This approach is consistent with the PRA’s principles-based approach outlined above, which allows firms to tailor their response in proportion to the materiality of climate-related risks to which they are exposed. This clarification has been set out in the new overarching considerations for the application of expectations section (paragraph 3.8) of the final policy. The PRA notes that the firm’s judgement of materiality applies across all aspects of the final policy, including risk identification, scenario analysis, and disclosures.^{footnote [2]}

2.22 The PRA expects firms to be able to demonstrate that their assessments of materiality are reasonable, proportionate, and subject to appropriate governance. Supervisors may request the evidence and rationale explaining how firms have identified material and immaterial risks, and the basis for any exclusions. The PRA also expects that firms’ materiality thresholds may evolve over time as climate science, data availability, and modelling capabilities continue to advance.

2.23 Several respondents also raised questions on the scope of the identification and assessment of climate-related risks arising from ‘material relationships’ with clients, counterparties, investees, and policyholders. The PRA clarifies that ‘material relationships with clients, counterparties, investees, and policyholders’ in paragraphs 4.25–4.26 of the final policy relates only to the materiality of climate-related risks. In this context, ‘material relationships’ refers to relationships that could significantly influence a firm’s climate-related risk profile within existing risk types (eg through credit, market, or reputational risks), including where a concentration of exposure arising from these relationships could amplify such risks. The PRA does not expect relationships that are material for other reasons, but immaterial from a climate perspective, to be included.

Cost benefit analysis

2.24 Many respondents agreed that climate-related risks were important for firms to manage, and that the proposed policy to improve the risk assessment and management of climate-related risks would have a net benefit for firms. However, some suggested that the PRA had underestimated the cost of implementing the updated expectations in its cost benefit analysis in CP10/25.

2.25 Respondents raising concerns about the cost estimates in the CBA typically interpreted the costs as covering the full cost of all climate-related capabilities, rather than the incremental cost of the proposed policy update relative to the observed baseline under SS3/19. However, the PRA based its CBA estimates on its assessment of firms’ observed existing baseline practices and investment in climate-related capabilities, put in place partly in response to the initial PRA expectations set six years ago in SS3/19. The CBA then estimated the incremental costs of the proposed policy compared to this baseline. These costs would stem mainly from improving implementation, for example enhancing scenario quality in scenario analysis or formally integrating climate risk appetites into existing governance structures. Accordingly, the PRA has not updated its CBA assessment.

2.26 In line with the approach for firms’ proportionate application of the expectations (paragraphs 3.9–3.22 of the final policy), the PRA also notes that a firm’s capabilities and, as a result, any implementation costs incurred, should reflect the level of climate-related risk to which it is exposed. This means that firms with little or no material climate-related risks would likely incur relatively low costs to demonstrate the immateriality of these risks, compared to firms with material climate-related risks that need to assess and manage those risks to a greater extent.

2.27 The PRA remains committed to supporting collaboration through industry initiatives, like the CFRF, which aim to reduce the financial burden on individual firms and foster more efficient integration of climate risk management practices across the sector.

Supervisory expectations

Governance

Corporate governance structures

2.28 The PRA received 22 responses related to the role of the board and senior management in governance of climate-related risks. Several respondents emphasised the importance of allowing firms to integrate climate-related responsibilities within existing frameworks, rather than establishing new processes. Similarly, two respondents requested recognition that different firms (eg internationally active banks) may follow a range of different governance frameworks for allocating responsibilities between UK entities, and the group-level boards.

2.29 As set out in paragraphs 3.9–3.22, the PRA’s final policy is intended to be applied proportionately by firms. The PRA expects the information provided to the board to be commensurate to the materiality of risks. The PRA expects the relevant Senior Management Function holder/holders (‘SMF’) to use their judgement to determine the information needed and the time required to consider it. The PRA recognises that the allocation of responsibilities between the UK entity board and group board may also vary between firms. Having considered the points raised by respondents, the PRA has decided to clarify paragraph 4.5 of the final policy to confirm that firms may use existing governance structures.

2.30 Some respondents noted that the proposed policy may be disproportionate for some firms, particularly where climate-related risks are less material, and sought clarification that a proportionate approach could be applied by firms. One respondent also suggested that encouraging the board to develop greater awareness of climate-related risks may lead to burdensome risk management practices for climate-related risks. The PRA considers that the two-step process for firms’ own proportionate application of the expectations (paragraphs 3.14–3.22 of the final policy), sets out that a firm’s assessment of its climate-related risks should inform its risk management response. A firm’s board-level involvement should therefore be proportionate to the level of material risks that it has identified and accepted.

2.31 Some respondents queried whether the proposed policy would create a new SMF specifically for climate-related risks. The PRA recognises that references in the proposed policy in CP10/25 to individual accountability for climate-related risks may have created some uncertainty. To clarify, there is not an expectation to create a new SMF role specifically for climate risk. The PRA has amended paragraph 4.6 of the final policy to refer to the SMF holder(s) or other senior individual(s) ‘responsible’, rather than ‘appointed’, to oversee the management of climate-related risks.

Risk Management

Risk identification and assessment

2.32 The PRA received 19 responses in relation to risk identification and the expectations for firms to define their climate-specific risk appetite. Respondents questioned the value of what they viewed as prescriptive expectations relating to the creation of specific climate-related entries in the risk register and the associated cascading of qualitative and quantitative risk appetites through to the business lines. The respondents were generally supportive of firms continuing with their existing approaches for risk registers and setting risk appetites.

2.33 The PRA considers that expectations for firms to include all material climate-related risks in risk registers is core to delivering the aims of the final policy. However, as noted above (paragraph 2.13), the PRA intends the expectations to be principle-based, rather than prescriptive, in delivering the intended outcome. The PRA has therefore clarified that firms should use their judgement to assess whether material climate-related risks should be incorporated in their existing risk register or within a supplementary sub-register. If using existing structures, firms should be able to explain how climate-related risks have been captured as part of those processes (see paragraph 4.20 of the final policy).

2.34 The PRA expects firms to identify material combinations of climate-related transmission channels and financial and operational risk types at the firm level. The granularity with which firms break down the transmission channels at the firm level, and when cascading risk appetite from board to business line levels, is for firms’ judgement. Similarly, firms may leverage appropriate existing risk management structures as opposed to developing stand-alone structures. It is expected that the chosen level of granularity should support the development of an effective but proportionate risk management framework. Risks deemed immaterial are not expected to be included in the risk register. Paragraph 4.20 of the final policy reflects these clarifications.

Client, counterparty, investee and policyholder risk identification and risk assessment

2.35 Several respondents sought clarification on the PRA's proposed policy regarding the process to assess risks arising from firms' relationships with clients, counterparties, investees and policyholders. Specifically, respondents asked whether firms must collect the relevant data required to inform these risk assessments directly from counterparties, or whether third-party data providers could be used. The PRA considers that firms may continue to engage with third-party data providers to support climate-related risk assessments. However, where material data gaps persist and cannot be resolved through those providers, firms are expected to consider alternative approaches to remediation. This may include, where appropriate, direct engagement with clients, counterparties, investees, or policyholders.

2.36 The PRA also acknowledges that insurers face limitations in the data they receive from reinsurers when conducting their counterparty risk assessments. For example, where a reinsurer provides cover to multiple insurers, it may hold sensitive information about those insurers (ie where they are competitors). If such information were inadvertently shared or used during counterparty risk assessments, this could give rise to competition concerns. In instances such as this, where complete climate-related data may not be available, firms should have in place contingency solutions using appropriate proxies, approximations and assumptions (paragraphs 4.74–4.76 of the final policy).

2.37 The PRA has decided to retain the proposed policy outlined in CP10/25, which is consistent with the clarifications made above.

Risk measurement and monitoring

2.38 Two respondents indicated that the risk categorisation of ‘accept, manage, avoid’ suggested for qualitative risk appetite statements is overly prescriptive. The PRA confirms that this categorisation is only a suggestion and not a mandated format. The final policy (paragraphs 4.12 and 4.32) reflects this clarification.

2.39 A number of respondents also questioned the link between entries of material climate-related risks in the risk register with qualitative and quantitative risk appetites, and the level of granularity expected of these. While qualitative climate-related risk appetite statements are expected to align with the firm’s risk register, there is greater flexibility in how quantitative risk appetites are implemented. The risk register and qualitative risk appetite statements provide a framework around which to build risk mitigation approaches. For material climate-related risks that a firm intends to manage through the use of quantitative risk appetites (eg limits), firms are expected to consider whether to manage the risk separately, with its own limit, or in combination with a broader category of risks, either within the climate-related risk envelope or in combination with other non-climate transmission channels.

2.40 In light of the considerations outlined above, paragraph 4.8 of the final policy clarifies the translation of risks in the risk register into qualitative risk appetites.

Operational resilience

2.41 The PRA received four responses in relation to operational resilience. Some respondents drew attention to an inconsistency between the proposed policy and SS1/21 – Operational resilience: Impact tolerances for important business services. The proposed policy expected firms to consider the operational resilience implications of climate-related risks, including those arising through third-party arrangements. However, the PRA agrees that the language used in the proposal may have implied an expectation of disruption prevention that exceeds the principles set out in SS1/21. To address this, the PRA has decided to amend paragraph 4.45 of the final policy to clarify that firms are expected to assess and manage the risks to operational resilience arising from climate-related events, including through appropriate mitigants and contingency planning. The PRA does not expect firms to remain within impact tolerances in scenarios that are beyond severe or implausible. This clarification will ensure consistency with SS1/21^{footnote [3]} and reinforce the principle of proportionality in resilience planning.

2.42 One respondent highlighted the use of the term ‘critical operations’ in the proposed policy, which is not defined in PRA rules, unlike the term ‘important business services’. The PRA has decided to update paragraph 4.44 of the final policy accordingly, to clarify and ensure consistency with PRA terminology. Considering the responses from firms, the PRA has also clarified (in paragraph 4.43) that references to ‘outsourcing and third-party agreements’ include intra-group arrangements.

Litigation risk

2.43 Twelve respondents raised the issue of climate-related litigation risk. They highlighted the evolving landscape marked by growing maturity and complexity of the risk and expanding avenues through which legal strategies are being deployed by parties (such as activists, claimants, governments and regulatory bodies) to advance their goals. Half of the respondents, particularly those from the insurance industry, requested litigation risk to be recognised as a distinct transmission channel, alongside physical and transition risks. Multiple responses noted that litigation risk has the potential to be a major source of risk for both banks and insurers.

2.44 The PRA agrees that climate-related litigation risk has become increasingly complex since the first climate expectations were published in 2019. While SS3/19 subsumed litigation risk (or liability risk) under physical and transition risk, the Financial Stability Board (FSB) noted in a 2022 report^{footnote [4]} that litigation risk can result from physical or transition risk, or materialise independently. Respondents cited the nascent rise of litigation against, rather than as a result of, climate transition. In light of these developments, the PRA recognises that for some firms, in particular for general insurers, litigation risk may materialise independently from physical and transition risks.

2.45 The PRA has observed that international standard setters differ in their approach to reflecting litigation risk. The BCBS views litigation risk as a subset of physical and/or transition risks^{footnote [5]} while the IAIS treats litigation risk as a distinct transmission channel.^{footnote [6]} Finally, the FSB adopts a pluralistic approach, recognising that litigation risk can both be a subset and can materialise independently.

2.46 Given the evolving and varied nature of litigation risk, the PRA expects firms to apply their judgement as to whether litigation risk is reflected as a subset of physical and/or transition risk or as a distinct transmission channel. The final policy has been changed accordingly (see paragraphs 2.1 and 2.5). The PRA expects the approach taken to reflect the firm’s business and risk profile, and to be consistent with how the firm identifies and assesses such risk. Where litigation risk is treated as a distinct transmission channel, the PRA expects firms to interpret references to transmission channels throughout the SS to include litigation risk, where relevant. This approach is consistent with the FSB, and accommodates the different approaches set out by the BCBS and IAIS. The PRA has also added references to litigation risk in the banking-specific chapter of the final policy (see paragraph 4.110).

Climate scenario analysis

2.47 The PRA received 29 responses in relation to the role of climate scenario analysis (CSA). The PRA’s proposed policy aimed to improve firms’ calibration and design of CSA to better tailor CSA for specific use cases. The intent was also to encourage firms to properly take account of the limitations of CSA, to help inform better decision-making.

2.48 Many of the responses sought greater clarity and guidance on the use of CSA. Some respondents suggested more detailed expectations for assessing scenarios, others requested that the PRA explain the applicability and limitations of specific scenarios, and a few requested reference scenarios to be provided. Some respondents also identified areas where the PRA could clarify its expectations for scenario design, including how these could be applied proportionately by firms. This included the use of narrative-based versus mathematically sophisticated scenarios, clarity on the appropriate time horizons for different use cases, and the number of scenarios expected per use case. The feedback to these responses is covered below.

Proportionate application of CSA expectations by firms

2.49 The PRA recognises that a range of design options can be used in CSA, including qualitative and quantitative approaches. In line with the ‘Proportionate application of expectations’ (paragraphs 3.9–3.22 of the final policy), the PRA has also added clarifications to paragraphs 4.47 and 4.49 of the final policy on the proportionate application of CSA. These clarify that firms’ design choices for CSA should be proportionate to a firm’s level of exposure to material climate risk and its size.

2.50 To clarify that narrative scenarios can be as valuable as quantitative scenarios to inform outcomes and decisions, the PRA has clarified all references to ‘sophisticated’ scenarios in the final policy to refer to ‘mathematically sophisticated’ scenarios across the final policy.

Scenario selection and use cases

2.51 Firms, rather than the PRA, are expected to select, match and tailor scenarios for their specific objectives and use cases. However, the PRA will continue to support the work of international standard setters, industry groups and academic institutions in their development of climate scenario repositories. As set out in paragraphs 3.26–3.28 of the final policy, industry bodies such as the CFRF will also play a key role in integrating evolving scientific insights into industry tools, including for CSA.

2.52 Some respondents sought clarification on whether the expectations under the ‘Scenario selection and use cases’ section of Chapter 3: Climate scenario analysis, expected multiple scenarios for each use case. The PRA expects firms to determine the appropriate number of scenarios based on the specific use case and the level of materiality of climate-related risk exposure. Additional clarification has been included in paragraph 4.53 of the final policy, explaining how the number and type of CSA exercises should be commensurate with the firm’s climate risk exposure.

2.53 The PRA has also updated paragraph 4.51 of the final policy to clarify how firms should proportionately apply the expectation for CSA to cover all material risks. This amendment explains that firms can apply their judgement to select scenarios that best suit their risk profiles. Firms will be expected to make judgements on the balance of using narrative-driven scenarios alongside mathematically sophisticated models and tailoring any externally sourced scenarios to meet any firm-specific needs. This will ensure that climate scenario analysis can be applied in a way that supports sound decision-making.

Time horizons

2.54 The PRA has set out the appropriate time horizons for impact analysis (paragraph 4.21) and the key principles for scenario analysis (paragraph 4.56). A key feature of CSA is the expectation to consider shifts in market expectations for the manifestation of severe climate shocks. Firms should consider both the financial impact horizon and longer-term horizons that may shape market expectations. Short-term scenarios may need to reflect how long-term projections influence market behaviour. In such cases, the financial crystallisation horizon may be 1-5 years, but the underlying scenario pathways could span multiple decades.

2.55 Given the directional nature of climate risks over longer periods, firms may choose to extend strategic planning horizons. The PRA agrees that longer-term analysis should rely more on narrative scenarios and less on precise quantification. The PRA has added paragraph 4.60 to the final policy to clarify this.

Reverse stress-testing

2.56 There were 13 responses relating to proposed policy for the use of reverse stress testing and its usefulness in understanding the likelihood of adverse climate-related risks that would render the business model unviable. Some respondents recognised the value of this tool to help ensure that a firm’s assessment of the level of risk is rigorous. Other respondents argued that exercises conducted under the true definition of a ‘reverse stress test' (ie that identify the point of failure of a firm solely due to climate-related risks) would use scenarios that are not informative. They suggested that climate factors would be better incorporated into existing macro reverse stress tests rather than addressed on a stand-alone basis. Some respondents relatedly felt that reverse stress testing analysis was of little use for internal risk management and disproportionately expensive for its value (ie the complexity and cost of reverse stress testing for climate-related risks outweighs its benefits).

2.57 The PRA recognises that decision-making in the context of climate-related risks involves significant uncertainty (see paragraph 3.25 of the final policy) and firms will need to apply judgement in their climate risk assessments. To support sound decision-making in this context, firms are expected to use scenario-based tools to support their understanding of the range of plausible outcomes and the resilience of their business models.

2.58 The PRA acknowledges that for more remote risks, both in terms of time and likelihood, firms may apply their judgement to use simpler tools such as scenario-based sensitivity analysis as an alternative to reverse stress testing. Scenario-based sensitivity analysis enables firms to test the robustness of scenario outputs by exploring how variations in key assumptions and key risk drivers (such as climate pathways, policy responses, or exposure profiles) could affect outcomes. Given the uncertainties inherent in climate scenario analysis outputs, the PRA expects all firms to use scenario-based sensitivity analysis to support their understanding of the assumptions embedded in their decision-making and to assess the consequences of those assumptions under a range of plausible scenarios.

2.59 The PRA considers that reverse stress testing can help firms test the boundary of risk materiality and improve the firm’s understanding of the climate-related risks it has chosen to accept. However, this may be more relevant for firms that are materially exposed to climate-related risks. It can also play a role in the identification of emerging risks to a firm’s business model. However, the PRA recognises that reverse stress testing may not be useful or proportionate for all firms.

2.60 The PRA has consequently changed the expectations so that it is clear that firms should choose to use scenario-based sensitivity analysis and/or reverse stress testing as appropriate and proportionate for their business model and level of exposure to climate-related risks (see paragraph 4.59 of the final policy).

2.61 For both sensitivity analysis and reverse stress testing, the PRA also recognises that narrative-based scenarios, with largely judgement-based quantification, can be appropriate for understanding longer-term and less likely scenarios. This clarification has been added to paragraph 4.64 of the final policy. The level of sophistication of any tools used should reflect the firm’s risk exposure and size (in line with the proportionate application of expectations in paragraphs 3.9–3.22 of the final policy). Firms should also remain aware of the limitations of the tools and approaches they select and apply prudent interpretation when using the outputs to inform decisions.

Data

Contingency solutions for data gaps

2.62 The PRA received 19 responses in relation to the quality and consistency of data sources and the challenges of data governance. Many respondents raised the issue of gaps in the data required to understand and manage climate-related risks. A wide range of data issues were raised by respondents. These covered directly measured quantities (eg emissions data using satellite observations), expert forecasts (eg real economy firms’ projections of their own future emissions), and the output of complex models (eg climate and economic projections).

2.63 Respondents queried whether there is more the PRA can do to help firms address these difficulties and similar concerns related to data quality, for example, by reviewing climate data sources (one respondent) or promoting shared collaborative efforts and repositories between firms (two respondents). In line with the overarching principles of the final policy, firms are expected to take responsibility for sourcing the data necessary to manage the climate-related financial risks to which they are exposed. Firms should interpret such data to inform decision-making, while remaining cognisant of its limitations and inherent uncertainty. This includes understanding of the key assumptions and limitations in the underlying data inputs (eg from third party data providers) and in any outputs generated by their own models (eg in CSA).^{footnote [7]} The PRA intends that by setting clear expectations for firms’ use of data, including the expectation to understand its assumptions and limitations, it will incentivise improvements in both the quality of data produced and the transparency of associated documentation provided by data providers.

2.64 Four respondents asked for further guidance on strategies to close data gaps, with one respondent suggesting an asset class or geographic materiality focus. The PRA considers that a firm’s strategy for closing data gaps should be in line with its own risk appetite. It is for firms to judge where to prioritise the closing of data gaps based on the materiality of the risks faced.

2.65 Finally, the PRA agrees with two points raised by respondents with respect to data and has changed the final policy accordingly:

• Paragraph 4.74: The PRA acknowledges that the expectation to ‘quantify’ data uncertainty would be prescriptive. As such, the expectation has been changed to understanding data uncertainty.
• Paragraphs 4.76 and 4.38: The final policy has been changed to explain that firms do not need to choose conservative proxies in cases where data, models or risk measurement tools are not yet adequate to measure risks accurately or to calculate reliable metrics. Instead, firms are expected to choose appropriate proxies and be cognisant of any weaknesses when interpreting any analysis based on them.

Governance of data provided by external suppliers

2.66 Eight respondents noted they are considering their use of internal and third-party data, with some querying whether the PRA has any views on whether firms should primarily rely on one or the other.

2.67 The proposed policy is not intended to prioritise one data source over another. Instead, firms are expected to understand, with appropriate depth, the limitations and uncertainty in the data they use. Where firms believe they can improve on third-party data services, they may choose to consider internal data sourcing. The PRA has decided to retain the proposed policy.

Disclosures

2.68 Respondents broadly supported the PRA’s approach of not introducing new disclosure expectations at this time, and instead reaffirming the expectation that firms engage with wider initiatives on climate-related risk disclosures. This enables firms to focus on implementing existing and new disclosure requirements introduced by other bodies, without creating duplicative or burdensome requirements. The broader expectations in the final policy support effective risk management, which should strengthen firms’ ability to produce high-quality, decision-useful disclosures.

2.69 The PRA received some requests to provide more information on the PRA’s expectations for specific aspects of climate-related disclosures, for example transition plans, impact on loan loss provisions, and assurance over disclosures. The PRA continues to engage with other bodies and industry, and to encourage high-quality disclosures in the context of corporate reporting requirements. Consistent with its approach to support rather than duplicate the work of other bodies, the PRA has decided not to add expectations in response to these requests.

Banking-specific issues

Assessment of climate-related risks in the context of ICAAPs and ILAAPs

2.70 The PRA received 12 responses to the proposed policy related to banking-specific issues on the integration of climate-related risks into the Internal Capital Adequacy Assessment Process (ICAAP) and Internal Liquidity Adequacy Assessment Process (ILAAP). While most respondents supported the inclusion of climate risks in these frameworks, they requested more detailed guidance on how to implement the expectations effectively and proportionately.

2.71 Several respondents queried whether the time horizons applied to climate scenarios within ICAAPs and ILAAPs should be consistent with those used in the two respective processes. While some supported alignment for ICAAP/ILAAP purposes, others noted that longer-term horizons may be more appropriate for strategic planning. The PRA considers that firms can align the scenario horizons used in ICAAPs and ILAAPs with the standard timeframes used in those processes. However, firms may also consider longer-term scenarios where relevant for broader strategic or business planning purposes that may also inform risk management. Paragraph 4.57 of the final policy clarifies this point.

2.72 Respondents also sought clarification on whether climate-related risks that are deemed immaterial should still be included in ICAAP and ILAAP submissions. One respondent suggested that climate-related liquidity risks should be excluded from the ILAAP where they are assessed to be immaterial.

2.73 The proposed policy set out that banks are expected to be able to evidence as part of their ICAAPs and ILAAPs how the judgement on risk materiality was made, including for those risks deemed immaterial. This keeps the final policy aligned with existing regulatory approaches, such as SS31/15. The PRA does not expect firms to include an explanation within the ICAAP or ILAAP as to why such risks are considered immaterial. However, in line with SS31/15, the PRA expects firms to be able to evidence how the judgement on risk materiality was made in their ICAAP, including for risks deemed immaterial, if asked by their supervisor. The PRA confirms this has been clarified in the final policy (paragraph 4.103–4.104).

2.74 One respondent suggested that climate-related considerations should be limited to strategic planning and not included within the ILAAP. The PRA maintains that where climate-related risks are sufficiently material to inform a firm’s strategic planning, they should also be appropriately reflected in the ICAAP and ILAAP. This approach is consistent with the PRA’s broader expectations for the integration of climate-related financial risks into firms’ capital and liquidity adequacy assessments, as set out in the final policy. The PRA continues to expect firms to embed climate risk considerations proportionately and in line with their materiality assessments. The PRA has therefore decided to retain the proposed policy outlined in CP10/25.

2.75 Separately, the PRA has also changed paragraph 4.106 of the final policy to state that ILAAPs are only expected to consider stressed scenarios, as opposed to a central case, when firms are assessing their climate-related risks.

Climate-related considerations for financial reporting

2.76 The PRA also received 11 responses in relation to financial reporting. Respondents did not raise significant concerns regarding reporting, though some comments reflected broader themes observed across the consultation process. For example, two respondents questioned the realism of expecting firms to have sound practices and policies to factor climate-related risks into balance sheets given ongoing challenges around data availability and modelling uncertainty.

2.77 The PRA acknowledges these challenges and recognises that firms are at varying stages of maturity in their climate risk capabilities. Nonetheless, the proposed policy remains consistent with the level of quality required for financial statements generally. Incorporating climate considerations into balance sheet assessments and maintaining robust policies and practices are essential for compliance with accounting rules and for meeting audit standards. Proportionality is a core principle underpinning the final policy (see the proportionate application of expectations in paragraphs 3.9–3.22 of the final policy), and this principle also applies here. The PRA has decided to retain the proposed policy.

2.78 One respondent requested clarity on the expectations on quantifying the impact of climate-related risks on balance sheets and financial performance. The PRA’s proposed policy is aligned to existing accounting standards and does not impose additional requirements. The PRA has decided to clarify this in paragraphs 4.95 and 4.96 of the final policy to include references to materiality.

2.79 Another respondent sought further clarity on expected credit loss (ECL) calculations and the quantitative analysis of climate-related risks at both individual and portfolio levels (paragraph 4.100 of the proposed policy). The PRA has decided to add clarity by more closely aligning the wording with the BCBS’s 2015 guidance on credit risk and accounting for credit losses. This reinforces the consistency of the PRA’s expectations with established international guidance.

2.80 Additionally, three respondents requested more detailed guidance on incorporating climate scenarios into ECL assessments. While the PRA recognises the importance of scenario analysis, it does not prescribe a specific methodology, given the diversity of firms’ systems and approaches. For completeness, the PRA has updated paragraph 1.2 of the final policy to include the September 2025 letter on ‘Thematic feedback on accounting for IFRS 9 ECL’ among the documents published in recent years that provide feedback to firms on managing climate-related risks.

Insurance-specific issues

2.81 The PRA received four responses on insurance related risk appetite. Respondents sought clarity on whether the PRA expects firms to fully incorporate climate risk into their levels of acceptable loss for risk appetite purposes, with respondents noting this is a particularly onerous and challenging exercise. Respondents also noted the shorter decision cycles of underwriting, which made it difficult to link long-horizon climate scenarios with underwriting changes and firm risk appetite. Respondents also asked whether the PRA expected specific evidence of compliance with the Prudent Person Principle (PPP) in the context of climate-related risks.

2.82 The PRA notes the examples included in the proposed policy were not intended to form new expectations beyond existing PRA rules and expectations, but to help firms with potential approaches to modelling climate-related risks. As set out in paragraph 2.33 above, the specific approach to capturing climate-related risks is left to firms’ judgement. The PRA has amended the wording in paragraphs 4.122 and 4.123 of the final policy for clarity.

2.83 The PRA is not introducing additional expectations in terms of evidencing the PPP relative to those set out in the SS1/20, as referenced in the final policy.

Own Risk and Solvency Assessment (ORSA)

2.84 Some respondents raised concerns in relation to expectations for the ORSA set out in the proposed policy. These included challenges around setting management actions given the very different time horizons between CSAs and underwriting cycles. Respondents raised concerns about the expectation to integrate CSA or Stress and Scenario Testing (SST) outputs into ORSA and risk appetite frameworks where those outputs do not meaningfully inform near-term decisions. One respondent suggested the expectations should be extended to also consider the impacts that firms’ climate scenarios would have on management actions.

2.85 While the time horizons may be shorter for underwriting decision cycles, the PRA notes that its existing expectations for insurers (for example in SS19/16 – Solvency II: ORSA) are for firms to consider future risks that may crystallise beyond the business planning period, as this can still impact the decisions firms make in the short term. See paragraph 2.54-2.55 above for further feedback on this topic. The PRA has clarified this by amending paragraphs 4.124 and 4.126–4.128 of the final policy

Integrating climate-related risks in insurers’ Solvency Capital Requirement

2.86 14 respondents asked for greater clarity regarding how climate risk should be reflected within the Solvency Capital Requirement (SCR).^{footnote [8]} In relation to internal models, four respondents sought clarity on whether climate risk should be captured as a separate risk or separate capital measure, and whether climate risk is appropriately reflected in the standard formula SCR. In addition, given that the SCR is based on a one-year time horizon, some respondents questioned whether the SCR aligns well with the long-term nature of some climate-related risks. A few respondents sought clarity on the expectations set out in paragraph 4.130 of the proposed policy for insurers with long-tail liabilities, including whether the PRA expected any supplementary analysis. Respondents also questioned how the PRA would ensure consistency of credit risk assessment across insurers. One respondent also questioned whether the emphasis on using quantitative models was appropriate given the known limitations in model design.

SCR: General provisions

2.87 The PRA acknowledges that climate-related risks tend to be longer term and may not align perfectly with the one-year time horizon of the SCR calculation.^{footnote [9]} The inclusion of CSA as part of the ORSA is intended to help firms to further assess and reflect the characteristics of climate-related risks (as per paragraph 4.58 of the final policy).

2.88 The PRA considers that the existing SCR Rules provide sufficient flexibility for firms to take account of climate risks in ways that they consider appropriate. Under the SCR Rules, a firm’s SCR must be calibrated to ensure that all quantifiable risks are taken into account^{footnote [10]} but there is no requirement for a separate or new climate risk capital requirement. The PRA has made clarifications to paragraphs 4.129 and 4.130 of the final policy to reflect this. The PRA has also clarified paragraph 4.131 to reflect that quantitative tools can also include narrative scenarios quantified with expert judgement.

SCR: Internal models

2.89 For internal models, the PRA considers climate-related risks to be risk drivers in various components of the SCR. In many cases, these may be additional risk drivers that affect existing components of an internal model. The PRA expects each firm to determine the appropriate method for the calculation of their SCR^{footnote [11]} and, under its supervisory framework, the PRA checks whether firms’ internal model approaches remain appropriate.^{footnote [12]} The PRA's policy intent is set out in paragraph 4.118-4.119 of the final policy and no further changes have been made.

2.90 The PRA recognises that climate risk modelling is evolving in paragraphs 3.23–3.25 of the final policy. Insurers should therefore continue to refine their approach as tools and best practice evolve. The PRA also acknowledges that there may still be limitations in the current climate modelling capabilities that insurers use in their SCR calculations, particularly for internal models.

SCR: Standard formula

2.91 In line with the PRA’s existing SS19/16, where a firm uses the standard formula to calculate some or all of its SCR, the PRA expects the firm to consider where its risk profile, including for climate-related risks, may significantly deviate from the assumptions underlying the standard formula and address this in its ORSA. This consideration of standard formula appropriateness is a core part of the ORSA and should be embedded in firms’ risk management and decision-making processes.

2.92 The PRA recognises there may be circumstances where requiring a firm to develop an internal model to calculate part or all of its SCR may be inappropriate or has been ineffective. The PRA would consider setting a capital add-on where it judges a firm’s use of the standard formula to be inadequate.^{footnote [13]} Where a firm judges the standard formula to no longer be appropriate, for example due to an assessment of material climate-related risks, it may need to consider applying to the PRA for a partial or full internal model. In such instances, firms should refer to the PRA‘s existing approach to reviewing and assessing firms’ internal models set out in Chapter 5 of SoP3/24. The PRA has therefore not made any additional changes to the final policy in the updated SS on this point.

2.93 Some respondents asked for clarity regarding the treatment of internal credit ratings, in particular relating to the methodologies adopted by credit rating agencies (CRAs). Regarding the SCR calculation, the PRA expects a firm to consider the impact of climate-related risks on the credit risk components of the SCR across all assets, whether internally or externally rated. The PRA has decided to clarify this in paragraph 4.136 of the final policy.

Reflecting climate-related risks on insurers’ regulatory balance sheets

2.94 For firms using a Matching Adjustment on the regulatory balance sheet, the rules relating to internal credit ratings are set out in rules 7.1 and 7.2 of the Matching Adjustment Part of the PRA Rulebook.^{footnote [14]} In meeting these requirements, where a firm considers that its internal credit rating may not make sufficient allowance for risks, including climate-related risks, it may make an appropriate adjustment to the Fundamental Spread as part of the MA attestation. Firms should not solely or mechanistically rely on credit ratings for assessing the creditworthiness of an entity or financial instrument.^{footnote [15]} The PRA has amended paragraph 4.139 of the final policy to clarify this policy intent accordingly.

Reflection of credit risk in market prices

2.95 In respect of the regulatory balance sheet, some respondents questioned whether existing market prices reflect climate-related risks. In relation to market prices, the approach for the regulatory balance sheet is set out in the Valuation Part of the PRA Rulebook.^{footnote [16]} The PRA has clarified this in paragraph 4.138 of the final policy.

Demonstration of material climate-related risks

2.96 One respondent asked for clarity on whether the PRA intends for an impact assessment to be performed where the impact of climate-related risks is deemed immaterial, to justify excluding a CSA from its ORSA. The PRA does not expect firms to include an explanation of the immaterial risks in the ORSA. In line with SS19/16, where a firm decides to accept a material risk, the PRA expects the ORSA to explain why that was considered appropriate (paragraph 4.124).

2.97 Furthermore, the PRA’s expectations for understanding the materiality of climate-related risks, including those included as part of the SST component of their ORSAs, are set out in paragraph 4.56 of the final policy. The PRA has therefore made a small clarification to this paragraph to note that CSA should also be used to incorporate material climate-related factors into reverse stress testing or sensitivity analysis as part of the ORSA (and ICAAP) to support risk appetite setting and development of loss limits.

Part VII guidance

2.98 One respondent raised concerns that Part VII transfers, which are used to novate or transfer insurance business, may concentrate historical climate-related litigation liabilities into a small number of specialist firms. An additional concern related to transferring firms that could face reputational or financial consequences, even if they are no longer legally responsible for the liabilities. The respondent requested a reference to this issue in the final policy (paragraph 4.137) and for the PRA to amend its existing SoP3/15 – The PRA’s approach to insurance business transfers.^{footnote [17]}

2.99 The PRA confirms that it is not currently planning to review or update SoP3/15. All firms, including insurers partaking in Part VII transfers, should consider all climate-related risks, including litigation and reputational risks, where material to their business and ensure they are reflected in the risk register per paragraph 4.20 of the final policy.

Natural catastrophes (NatCat) protection gaps

2.100 Four respondents highlighted the importance of considering NatCat protection gaps. There were concerns that enhancing firms’ management of climate-related risks could have implications for the availability and affordability of insurance, especially against the backdrop of the planned end of Flood Re in 2039.^{footnote [18]} One respondent suggested that the PRA should have a wider conversation with the Bank and the Government about future insurability.

2.101 The PRA acknowledges that while actions to improve firms’ climate-related modelling capabilities should improve the ability of banks and insurers to price and manage risks, there could be wider implications (and indeed this was factored into its CBA analysis). The PRA agrees that a collaborative approach between authorities and the UK financial sector is essential to ensure resilience to climate-related risks, which is a prerequisite for sustainable economic growth. In any case, the appropriate management by individual firms of their own risk exposures is an important mitigant to potential climate-related financial stability risks arising from the increasing physical impacts of climate change.^{footnote [19]} No changes have been made to the final policy.