A new report is warning that climate risks to physical infrastructure combined with other threats mean that losses from climate-related hazards will continue to rise unless investors, lenders, insurers and policymakers undertake significant risk management efforts.

The report, Physical risk framework: Understanding the impact of climate change on real estate lending and investment portfolios, has been published by ClimateWise, a global insurance network industry group supported and convened by the University of Cambridge Institute for Sustainability Leadership (CISL).

ClimateWise is also publishing new open-source models offering step-by-step guides to help the financial industry prepare for risks posed by climate change.

According to the global network of insurers, investors and lenders including mortgage portfolio holders need more support to identify, measure, mitigate as well as adapt and report the impact of climate change.

Average annual losses caused by floods to UK mortgages could more than double under 4°C of warming scenario

Under the most extreme projections with 4°C of warming, for example, average annual losses caused by floods to UK mortgages could more than double, putting pressure on insurers and exposing mortgage lenders.

The report describes flooding as “a major peril to UK assets”, pointing out that across the UK the most significant sources of flooding today are:

• fluvial (river) flooding (contributing £560 million/40% of total UK flood risk)
• coastal flooding (£320 million/24%)
• surface water flooding (£260 million/20%)
• groundwater (£210 million/16%)

The report warns that if current levels of adaptation continue, flood risks are projected to increase significantly by the 2080s (50 % under a 2°C climate change projection, 150% under a 4°C climate change projection, and sixfold under a high-end (H++) climate change scenario. When projections of population growth are included the risks increase further.

The report says that surface water is expected to represent the largest risk to UK assets in the commercial asset portfolios examined, both under present day and future climate scenarios.

It also warns of a potential increase in the funding gap for Flood Re, the scheme set up to provide an affordable market for home insurance for properties built before 2009 that are at risk of flooding. It achieves this by offering fixed premiums according to council tax banding, with the funding gap between the premiums it charges and the risk-based price for insurance met through a levy imposed on the insurance industry (and, ultimately, its policyholders).

The report says:

“This analysis suggests its funding gap could increase, reinforcing previous concerns about the sustainability of these arrangements.”

By statute Flood Re is required to shift the UK residential market back to risk-reflective pricing by 2039. After that date premiums and excesses should, as well as being risk-reflective, remain affordable without the benefit of the levy.

“Careful investigation will be required of whether and how Flood Re can achieve this in light of the projected increased risks arising from climate change”, the report says.

Absence of Flood Re insurance after 2039 has profound implications for both homeowners and mortgage providers

In the absence of Flood Re or for UK residential properties excluded from Flood Re (those built after 2009), the report warns that “implications for both homeowners and mortgage providers could be more profound. It is possible that, in some cases, this increase in risk will mean that buildings insurance for residential properties may no longer be available for some homes at an affordable price. …"

“A lack of access to affordable insurance would have adverse implications for homeowners living in those properties who may find that their properties suffer significant decreases in value, potentially leaving them in negative equity and either unable to sell their homes and/or unable to re-mortgage.“

“This could have significant personal costs, as well as disrupting the liquidity and efficiency of the housing and mortgage markets. In turn, lenders may need to consider the increased risk of mortgage default, which is likely to be geographically concentrated, and ensure that their business strategies are robust to this risk.”

The report’s illustrative results show property-level adaptation can play a key role in reducing this increase in risk, off-setting up to 65 % of the increase in losses.

In Physical risk framework: Managing the physical risks of climate change, the ClimateWise Advisory Council offers a practical guide for investors and lenders based on natural catastrophe models to help them understand changing physical risks and the impacts on their portfolios.

Focus on mitigation and adaptation will help maintain affordable insurance

David Rochester of Lloyds Banking Group said:

“The key observation of this report is – that we need to focus on both the mitigation of climate change, as well as adaptation to its effects, and that if we do both, we can maintain affordable insurance - is an important message and one that Lloyds Banking Group very much supports. This open-source tool will provide investors with the means of accessing the information they need to take action to mitigate climate risks and protect their assets.”

The report highlights that not all investors and lenders will be equally exposed, with significant differences in exposure between portfolios as well as within portfolios. While insurance will play an important role in managing the impact of climate change, the increase in risk could, in the most severe cases, make premiums unaffordable.

Majority of natural disaster losses still not covered by insurance

Even today, the majority of natural disaster losses are not covered by insurance. Swiss Re estimates that the total economic losses from natural disasters have averaged US$180 billion annually in the last decade. Of this, around 70% of risks from natural disasters remain uninsured, rising to 80–100% in emerging markets.

Dr Bronwyn Claire, Senior Programme Manager, CISL, commented:

“The project highlights how the measures necessary to mitigate and adapt to climate change should be factored in as potential transition risks, which could increase significantly by 2030.”

In a second report entitled Transition risk framework: Building capacity to manage the impacts of the low carbon transition on infrastructure investments, the ClimateWise Advisory Council explore how to quantify policy changes, reputational impacts, and shifts in market preferences, norms and technology as areas of possible risk and opportunity for investors.

The framework, which is aligned with the recommendations of the Taskforce on Climate-related Financial Disclosures (TCFD), guides investors through assessing their asset types exposed to transition risk and opportunity, defining the potential impacts and incorporating transition impacts into their financial models.

Geoff Summerhayes, Chair of the UNEP Sustainable Insurance Forum, said:

"The framework responded to a critical paradigm shift in the way financial supervisors and regulators consider climate change as a core prudential risk.”

Dominic Christian, Chair of ClimateWise and Global Chairman, Aon Benfield, added:

“US$94 trillion will be required globally, by 2040, to meet the world’s growing infrastructure needs. Yet it is crucial that this infrastructure both supports our transition to a low carbon future and is financially resilient to the inevitable social, economic and technological impacts this transition will bring. Exposure to infrastructure investments stretches across the financial services sector. Yet few asset owners are truly considering transition risk. These two reports will go some way to help address this.”

Click here to download Physical risk framework Understanding the impacts of climate change on real estate lending and investment portfolios

Click here to download Transition risk framework: Building capacity to manage the impacts of the low carbon transition on infrastructure investments

Click here to download Transition risk framework Managing the impacts of the low carbon transition on infrastructure investments Practitioners’ Step-by-Step Guide