Introduction

Risks such as climate change, nature and biodiversity loss, artificial intelligence and geopolitical instability are systemic and cannot be diversified away. Scenario analysis offers a practical way to navigate this uncertainty; however, its broader potential as a dynamic strategic tool remains underused, most commonly applied only to risk assessments, net zero target-setting and Task Force on Climate-related Financial Disclosures (TCFD) disclosure requirements.

Challenges to current approaches

Simplified quantitative approaches — often called first-generation climate scenarios — rely on historical correlations and likely understate the true scale of future impacts. Key drivers such as irreversible tipping points, widespread AI adoption, nature loss, conflict and climate-driven migration are rarely integrated into standard climate scenarios. Equilibrium macroeconomic models and Integrated Assessment Models may also drastically understate potential output and welfare losses at higher warming levels.

Why pension fund boards should engage on this

Boards can derive significant value from scenario analysis if engaged with effectively. Done well, it supports strategic insights, enhances stewardship prioritisation and addresses regulatory expectations. Supervisory bodies emphasise the importance of boards understanding the limitations of climate models, including non-linearities and tipping points. Boards must be confident in underlying assumptions and able to explain how insights inform investment strategy, risk management and stewardship decisions.

Bespoke scenario approaches: Practical examples

USS, the UK’s largest private pension fund with £76.8 billion of assets under management (p9), developed four transition narratives to 2030 using a non-linear macroeconomic model. This revealed a wide range of possible outcomes, including persistent inflationary pressures across all scenarios, prompting increased allocations to inflation-linked bonds and private market assets.

Norges Bank Investment Management (NBIM) uses a multi-method approach, estimating losses of between 8 and 10% of relative US equity value under a current-policies warming scenario (p10), rising to 12% under a disorderly scenario with significantly higher future temperatures (p10). A stress test of a hypothetical extreme weather events scenario estimated a total fund drawdown of 20%, with equities falling 24% and fixed income losing 10% (p10).

APG, with around €616 billion in assets under management (p11), begins with uncertainties rather than probabilities, developing narrative ‘worlds’ before any modelling through workshops with senior stakeholders, turning scenario analysis into a strategic learning tool that uncovers hidden assumptions and explores how different risks interact.

Top tips for chairs and trustees of pension funds

The guide sets out six practical tips for boards:

• Reframe scenario analysis as a strategic input, not a technical output — embed it into governance and fiduciary processes to inform capital allocation, risk management and overall risk appetite.
• Challenge linearity and false precision — push back on the exclusive use of simplified quantitative approaches and demand consideration of non-linear methods, uncertainty bands and narrative scenarios.
• Use narrative scenarios for regular board discussions — carve out protected board time, ideally annually, for narrative sessions covering climate, geopolitics, nature and macroeconomics over the next five to ten years.
• Direct scenario analysis to shorter, decision-relevant horizons — prioritise horizons of typically up to five years to better align analysis with the decisions trustees need to make on risk, resilience and asset allocation.
• Embed scenario insights into decision making and engagement — ensure insights simultaneously inform strategic asset allocation or default strategy design, portfolio resilience, liquidity management and stewardship escalation.
• Lead a mindset shift — invest in board and wider organisational capabilities, treat scenario analysis as a living process, and assign explicit responsibility for climate scenario literacy to a suitable sub-committee.