Adapting the Use Test framework to drive decision-relevant climate scenario analysis

A Use Test framework for CSA

Climate scenario analysis (CSA) has emerged as a key tool for understanding risk for insurers who sit at the intersection of physical risk losses, transition risks reshaping investment portfolios, and increasing litigation exposure. However, CSA is yet to step beyond understanding and into decision-making for many insurers. The Prudential Regulation Authority, through SS5/25, makes clear that scenario analysis should inform strategy, risk appetite and the Own Risk and Solvency Assessment (ORSA), and disclosure regimes such as Task Force on Climate-Related Financial Disclosures (TCFD) and International Financial Reporting Standards S2 reinforce these expectations, so how can insurers gain decision-useful insights from CSA?

This challenge of model use is not fundamentally new and echoes the early experience of internal model adoption under Solvency II. To ensure that Internal Models were genuinely how insurers managed their capital, rather than technical exercises in capital reduction, Solvency II proposed the Use Test, requiring model understanding by senior management, integration within risk management, and demonstrable evidence of supporting decision-making.

The same discipline provides a practical blueprint for making CSA decision-relevant rather than compliance-driven. By translating technical narratives into familiar language and embedding models into governance processes, insurers can move beyond minimum compliance and strengthen strategic resilience.

The Solvency II Use Test: a blueprint insurers already understand

Article 120 of Solvency II required internal models to be widely used and play an important role in governance and decision-making. In practice, this led to a cultural shift across many firms.

• Decision relevance became as important as technical precision – Boards were forced to engage with technical complexity, and in doing so, brought a wider strategic focus on areas of decision-making that capital modelling could explore.
• Functions integrated – Risk, actuarial and finance developed a consistent and defensible view of risk.
• A shared vocabulary developed – Terms such as “1-in-200” enabled structured discussions about uncertainty.
• Boards became informed users – Supervisors expected clarity on purpose, assumptions and limitations - not mathematical mastery.

These changes took time. Early models matured through iterative testing, validation and independent challenge before they became operationally useful. Making CSA decision-relevant will present a comparable task, firms need governance that complements technical rigour to ensure scenario outputs inform real decisions.

Parallels between capital modelling and CSA

Capital models stress test solvency under severe but plausible events. CSA explores resilience across plausible climate futures. Both rely on judgment, evolving data and assumptions about uncertain environments. Both can include technical, calibrated elements - and both can be used to create value, but only when designed to do so.

If CSA is to become decision-relevant, it must evolve to be decision-useful by design. In practice, this often means blending approaches.

• Qualitative exploratory scenarios for emerging risks and strategic discussion.
• Quantitative pathways, often aligned to Network for Greening the Financial System (NGFS) and Intergovernmental Panel on Climate Change (IPCC), where financial implications for investment strategy, capital planning or reinsurance need clearer assessment.

The choice is not between narrative and numbers, but between levels of depth and calibration. Firms should align the complexity of their analysis to the materiality of the decision it supports - maintaining technical rigour while ensuring governance converts outputs into action.

Both Internal Models and CSA have a core requirement for statistical validity and technical rigour. Under the Use Test, purpose came alongside precision however, CSA is yet to marry governance with granularity.

Lessons from Use Test integration and their CSA implications

Experience from internal model implementation points to practical actions.

1. Link technical outputs to decisions – Internal models created value when outputs were tied to strategic and operational choices. Establishing a clear CSA strategy built around well-defined purpose statements is essential to making CSA strategic.
2. Move beyond minimum compliance – Some firms treated the Use Test as a hurdle; others embedded it and strengthened their risk culture. CSA presents the same choice with the same obvious answer.
3. Integrate functions – Solvency II required a consistent view of risk across functions, risk, actuarial and finance. CSA should inform financial reporting, investment governance and product development, not remain confined to natural catastrophe modelling or sustainability reporting.
4. Build board literacy (To be clear, we do not expect transition pathway fluency for all) – In Andrew Bailey’s 2015 speech Governance and the role of Boards he famously observed that non-executives do not need to understand the mathematics of Gaussian copulas (“To be clear, we do not expect copula fluency for all”), but they do need to understand the assumptions and limitations of those models and foster an open culture of discussion, debate and challenge. The same logic applies to climate scenario analysis: nobody should expect a non-executive to derive transition pathways from an integrated assessment model; but they should absolutely be asking whether the assumptions are reasonable, whether the time horizons match the firm’s liability duration, and whether results are used to make real decisions. The climate scenario is the modern copula, and intellectual ownership of the challenge matters just as much.

Embedding CSA across the organisation - the golden thread in action

As with internal models under Solvency II, demonstrating meaningful use requires CSA to be visible across the organisation. Working with our clients, Crowe has identified a range of business operations that can be better supported by well designed CSA.

Making use of climate scenario analysis presents a comparable challenge to the early experience of internal model adoption under Solvency II. The Use Test framework offers a practical blueprint for making CSA decision-relevant rather than compliance-driven and gives insurers the tools and language needed to further enhance their scenarios and modelling. Firms that apply the lessons learned from the Use Test are more likely to develop an internally consistent view of climate risk - strengthening governance and supporting long-term resilience.

If you would like to explore how Crowe’s Climate Use Test framework might apply within your organisation, let’s discuss how we could support you. Please contact Alex Hindson or your usual Crowe contact for more information.