The Bank of England’s (BoE) Prudential Regulation Authority (PRA) published Supervisory Statement 5/25 last December, setting out its concerns over the systemic risks that climate-related factors present to banks and insurers. The regulator made clear that it expects firms to take a forward-looking, strategic, and ambitious approach to implementing its recommendations on an ongoing basis.
Ortec Finance, a provider of technology and solutions for risk and return management, recently examined the guidance and what insurers need to know.
The PRA has acknowledged that while the scale and timing of climate risks remain uncertain, they are foreseeable to a degree. Crucially, it has stressed that firms of all sizes may face significant exposure, with the severity of impact shaped largely by an institution’s business model and the geographical concentration of its balance sheet, Ortec explained.
For investment, risk, and sustainability teams at UK insurers, this means understanding how the geographical spread of assets within the investment portfolio influences climate risk exposure — as well as how physical climate risks could push up policy payouts, undermine insurability, and put pressure on solvency ratios.
When it comes to assessing and managing climate risk, the PRA expects insurers with material exposure to invest more heavily in monitoring and managing those risks than less-exposed counterparts. Given that climate risk is systemic in nature, the regulator anticipates that all insurance companies will fall into the materially exposed category, requiring them to build robust climate risk management frameworks capable of evaluating the resilience and vulnerabilities of their business models and investment strategies, it said.
For insurers with material exposure, the PRA identifies climate scenario analysis as a central tool for identifying, quantifying, and managing climate risks, as well as for conducting internal capital adequacy assessments under the Own Risk and Solvency Assessment (ORSA) framework. This approach reflects the fact that the nature of climate-related risks makes it inadequate to rely solely on historical data — the method typically used to assess more traditional risks such as inflation and interest rate fluctuations, it said.
The regulator also advises that assessments should be proportionate to both the scale of the risks and their proximity, taking into account time horizon and likelihood. For risks anticipated to emerge over longer time horizons, narrative-based scenarios are recommended.
In terms of specific risk categories, the PRA has offered more granular guidance. On physical risks, assessments must be geographically detailed enough to capture shifts in the frequency and severity of extreme weather events, as well as longer-term changes in precipitation and average temperatures.
For transition risks, insurers must assess exposures with sufficient sectoral granularity to capture risk dynamics and account for concentrations in transition-sensitive sectors such as fossil fuels.
On market risks, firms are expected to recognise that future returns may be more volatile than historical patterns suggest, with variation across sectors, sub-sectors, and regions — and to understand how traditional financial models such as Economic Scenario Generators account for climate-related factors.
Climate analytics firm Ortec Finance has developed proprietary climate scenarios designed specifically for investment decision-making, enabling insurance companies to measure, monitor, and manage portfolio climate risk.
The firm offers an integrated economic and climate risk management tool through its GLASS asset-liability management (ALM) software and ClimateMAPS — a climate scenario analysis solution.
GLASS uses economic scenarios that incorporate climate change and works alongside ClimateMAPS’ narrative-based climate scenarios to explore a broad range of potential climate-related economic and financial market impacts, providing what the company describes as one of the most comprehensive risk management tools available to institutional investors globally.
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