Jenny Clark and Theresa Löber
The UK’s climate continues to change, getting wetter and warmer, with extremes becoming ever more pronounced. Even if we limit global warming to 1.5°C above pre-industrial levels, experts warn that we’ll see the number and severity of extreme weather events increase further. Without adaptation, we will see more property, infrastructure and agriculture damaged or destroyed, with devastating consequences to households, communities and businesses – as well as increasing risks to economic and financial stability. To date there has been relatively more focus on mitigation and the transition to net zero than on adaptation and addressing physical risk, across both government and the private sector. Adaptation is mitigation’s sidekick, we need them to consistently work together to achieve better outcomes. Much like Batman and Robin.
Severe weather events are already happening, and will continue to worsen
We don’t have to look to the future to see losses from weather events. The devastating impact of flooding in Spain and hurricanes in Florida are dominating the news. And this is not confined to happening elsewhere: In 2023 in the UK, Storm Babet caused damage to crops predicted to be in the millions of pounds. The Scotland Environment Protection Agency had not expected a storm that severe for another 60 years, suggesting that damages are materialising sooner and more severely than originally thought. And in London, the London Climate Resilience Review’s 2024 report found that tidal defences upstream of the Thames barrier must be raised 15 years earlier than expected due to heightened risk of flooding from rising sea levels. This is essential to continue to protect an estimated 1.25 million people and £200 billion worth of property and infrastructure.
Even if we deliver the goal of the Paris Agreement to limit the increase in the global average temperature to 1.5°C, which is looking increasingly unlikely, most of the physical climate impacts over the next 20 to 30 years are already locked in due to past emissions. Insurers are already seeing an increase in weather-related claims, and this is set to continue. Annual natural catastrophe losses are exceeding US$100 billion and Lloyd’s has warned that the industry have not yet felt the full impact, with some climate events yet to translate into claims.
Those physical impacts from climate change create financial risks
These physical effects from climate change are one of two key channels through which climate change can create financial risks. Central banks have focused on physical risks (alongside transition risks) in their work on financial risks from climate change, and recently that work has started to include a more explicit focus on the role adaptation can play in reducing the impacts from physical risks, and hence financial stability risks.
But physical and transition risks don’t happen in isolation. In fact, they are closely interlinked – climate mitigation efforts will determine the extent of climate change in decades to come, and what level of temperature increases we ultimately need to prepare for and adapt to. Adaptation is the other side of this: the process of adjusting to actual and expected future climate change, such as floods and droughts, with the goal of reducing risks and adverse impacts.
Adaptation is crucial to the resilience of the UK economy, and makes economic sense
Adaptation measures would protect existing assets such as infrastructure, housing, and agriculture, as well as ensuring that new ones are designed with future climate change impacts in mind and are themselves resilient to climate change. It can take many forms, specific to local circumstances, from building flood defences to early warning systems to nature-based solutions such as flood plains.
But unlike the net-zero by 2050 target for mitigation, the framework for the Global Goal on Adaptation agreed at COP28 does not have quantified targets. And any target will need to reflect over time how successful our mitigation efforts are. The aim of adaptation is not to eliminate the possibility of any damage, but rather to reduce the risk to a level that means the economy is ‘climate-resilient’ – prepared for different extreme weather events, able to withstand them and recover quickly when they happen.
In the absence of clear targets it is difficult for the market and policymakers to determine the right level of adaptation since it is a policy choice between reducing the potential for damage, what is covered by insurance, and what is residual. An additional complication is that international and UK goals aim for a 1.5°C world, but financial firms will need to undertake contingency planning for temperature outcomes higher than this including eg 2.5°C by 2050 – involving both adaptation and mitigation measures. What is clear is that we need to reduce the level of risk and reliance on insurance to cover the damages, while acknowledging that adaptation measures can also enable insurers to offer coverage.
The UK’s Committee for Climate Change estimates that in many cases the costs of adapting are lower than dealing with the fallout after an extreme weather event. And the Green Finance Institute’s Mission Climate Ready report argues that an adequate policy, fiscal, and regulatory environment needs to be in place to enable adaptation action and investment. Despite this, adaptation lacks considerably behind mitigation efforts. Batman can’t tackle this alone – we need Robin alongside.
Lack of adaptation could create risks for financial stability
In the absence of system-wide adaptation – and better policy and regulation to enable it – greater physical risks transmitting through the economy means potential issues for financial stability. In the Bank of England’s Climate Biennial Exploratory Scenario (CBES), the most severe scenario related to increased physical risks and saw the highest losses for banks and insurers across the exercise. And other central banks’ scenario exercises have shown similar results.
On the real economy side, severe weather events can disrupt supply chains, impacting businesses’ profits and employment of workers. In turn, both businesses and workers may struggle to repay loans and mortgages, and reduce their spending, impacting the economy.
Typically, the economy relies on insurance to deal with some of that risk. As climate change events become worse, and losses against insured assets increase, insurers will reassess where they are willing to provide coverage and at what cost. Potentially high insurance premia mean that the reliance on insurance in place of adaptation is an economically inefficient allocation of resources, and ultimately more costly for firms and households. And there is an increased likelihood that insurance premia increase beyond affordable levels, or coverage is withdrawn altogether. At the moment, Flood Re provides flood insurance coverage to domestic properties in the UK deemed at significant risk of flooding, but is set to end in 2039 with the aim of ensuring a long-term sustainable market after that date.
An insurance protection gap can spill over to banks that typically only issue mortgages if insurance is in place. But if that insurance is not renewed, either because the cost is too high or it is unavailable, then losses will sit with banks in case of damage to the underlying asset. Banks could experience losses if businesses and households face stranded assets due to damage from physical risk events, or a reduction in house prices because of that perceived risk. If this happens, banks could subsequently tighten credit conditions or withdraw products from the market, impacting economic activity.
Physical risks from climate change could also affect financial stability by causing market volatility if those risks are under-priced. If investors simultaneously realise that asset values are inflated, this could lead to a sudden market correction – also known as a climate ‘Minsky moment’.
More adaptation efforts could reduce financial stability risks, and are therefore part of the solution.
Action on adaptation needs to be integrated with mitigation strategies
Recent evidence shows that financial institutions accounted for physical risks less than transition risks in their transition plans, which could lead to a lower level of action to manage those risks. For those plans that do exist, improvements are needed, for example via the work of the Adaptation Working Group at the UK Transition Plan Taskforce.
That lack of preparation on part of businesses and financial firms creates financial and economic risks. But it also risks missing the crucial opportunity of embedding adaptation with mitigation – integrating the two would be the least costly and most efficient way to create a UK economy that is climate-resilient. This is why adaptation and mitigation should be thought of as two equal parts of the same puzzle for addressing the impacts of climate change.
We should be giving as much consideration to risks arising from severe weather events and the lack of preparedness, as we do to risks arising from the transition. Acting now on mitigation strategies reduces the need for increased adaptation in future, but we still need some level of adaptation now alongside these mitigation efforts given that some impacts are locked in. To achieve the best outcomes to deal with climate change, and to protect economic and financial stability, Batman needs Robin.
Jenny Clark and Theresa Löber work in the Bank’s Climate Hub Division.
If you want to get in touch, please email us at bankunderground@bankofengland.co.uk or leave a comment below.
Comments will only appear once approved by a moderator, and are only published where a full name is supplied. Bank Underground is a blog for Bank of England staff to share views that challenge – or support – prevailing policy orthodoxies. The views expressed here are those of the authors, and are not necessarily those of the Bank of England, or its policy committees.
Share the post “Adaptation is to mitigation what Robin is to Batman”
