Climate change is no longer just a physical risk issue; it is increasingly a financial stability issue. As climate hazards intensify and become less predictable, insured losses will continue to rise, leading to greater tightening in insurance markets.
This is likely to result in a widening protection gap, where an increasing proportion of economic activity and value is left uninsured or underinsured. This report argues that insurability is the critical transmission channel connecting climate risk to the wider economy. When insurance becomes more expensive, narrower, or unavailable altogether, the effects spread into lending, investment, asset valuations, and public finances. In turn, this reduces bankability and investability across the real economy. The protection gap is therefore not just an insurance problem; it is a challenge to capital formation, economic recovery and long-term growth.
This is not a risk from which the UK is immune. The UK Climate Change Committee estimates that around £11bn of annual investment is required to support national adaptation and resilience. However, financing remains constrained by valuation bias, short term horizons, fragmented project pipelines, and the public-good nature of many resilience measures. Without faster progress, underinvestment in resilience risks reinforcing a negative loop in which rising losses weaken insurability, further discouraging private investment and placing greater pressure on the public sector.
As a leading global centre for insurance and capital markets, the UK is also exposed not only to domestic climate risk, but also to broader shifts in global financial conditions. The insurability challenge therefore presents both a risk and an opportunity: meeting domestic and global adaptation and resilience needs will require significant capital mobilisation, with the UK’s financial markets well placed to play an important role. The paper sets out a practical agenda for action. Among other things, it calls for:
earlier pricing and governance of physical risks
improved mechanisms for recognition of resilience measures in insurance and financing terms
a growing pipeline of investable adaptation projects
greater use of blended capital
targeted public backstops where markets alone cannot deliver.
The central message is clear: adaptation and resilience should be treated as core economic infrastructure. They are not discretionary costs, but essential for preserving insurability, protecting asset values, and supporting the effective functioning of capital markets in a climate constrained world.
Climate change and the risks to insurability
Climate change is driving a measurable increase in average global temperatures as greenhouse gases accumulate in the atmosphere, altering historical climate norms and weather patterns. This warming is already reshaping the nature of physical climate risk and is expected to continue to do so as greenhouse gas emissions continue to rise globally.
At the same time, development patterns and interconnected supply chains are increasing exposure and concentrating vulnerabilities. This means that physical impacts are less likely to remain localised and more likely to cascade through socio-economic systems.
These shifts have the potential to test the assumptions that underpin risk pricing in financial markets, underwriting of physical climate risks and long-term investment decisions. As hazard, exposure and vulnerability levels rise and uncertainty in forward-looking models persists, the availability, affordability and adequacy of capital is likely to come under strain.
One of the most immediate risks is to the availability of insurance capital, or capacity, in the face of increasingly frequent and severe extreme weather. This is material because historical evidence indicates that when insurance markets weaken, the effects extend far beyond individual policyholders and affect wider financial and capital markets. This is because of insurance’s role as a foundational layer in the wider financial ecosystem, transferring risk in a way which enables the functioning of debt and equity markets and supports financial stability more broadly.
Against this backdrop, investment in adaptation and resilience measures that mitigate physical climate risk and promote insurability is becoming increasingly critical to the integrity of financial systems. In the UK, the Climate Change Committee (CCC) estimates that £11bn of annual investment is required to mitigate the impact of climate change.
Yet structural challenges continue to limit both public and private adaptation and resilience financing at the scale and pace required. A key reason is that benefits are often realised as avoided losses across multiple stakeholders, and are not always captured in traditional valuation approaches, disincentivising investment. The result can be a reinforcing cycle: insufficient resilience increases losses and uncertainty, which further strains insurability and tightens wider financial market conditions, limiting the availability of the financing needed to manage risk.
From insurability to bankability and investability: insurance as a foundation
The challenges facing risk transfer markets in a changing climate have wider significance because of the fundamental role insurance plays as a foundation for wider capital markets.
Insurance is often described as a ‘first line of defence’ because it performs functions that extend beyond claims payment. It helps price risk, supports proportionate and growth generative risk-taking, and supports recovery by providing liquidity after loss events. It also supports wider financial activity. In debt markets, mortgages, construction finance, project finance and corporate lending typically rely on adequate insurance as a condition of funding. Equity investors often also require confidence that appropriate risk transfer measures are in place before investment.
Where insurance is unaffordable or unavailable, this can increase the cost of debt as lenders adjust pricing to reflect the additional retained risk. Uninsurability can also transmit into equity markets – either directly or as a result of the debt-stress mechanism described above – by increasing the cost of equity and constraining access to capital. This combination of debt and equity pressure can ultimately affect asset valuations, causing economic activity to slow. This is not necessarily because the underlying projects or transactions are no longer operationally unviable, but because the inherent risks cannot be efficiently transferred.
Responses and innovations
Awareness is growing globally of the threat that physical climate risk poses to insurability and, in turn, to capital markets. A range of responses are emerging to address the insurability challenge, with further innovation likely in the years ahead.
Insurance market responses: Alternative Risk Transfer (ART)
Alternative Risk Transfer (ART) solutions are innovative mechanisms beyond traditional (re)insurance that enable more flexible and capital-efficient risk transfer. They can diversify capital sources, stabilise insurance costs in volatile markets, and expand capacity for hard-to-place risks. While not developed specifically in response to the climate insurability challenge, several ART solutions could help narrow growing protection gaps and reduce the risk of stranded assets.