Understanding Physical Climate Risks in Portfolios 

With average global warming reaching 1.5°C above pre-industrial levels in 2024, physical climate risks have shifted from long-term projections to immediate financial realities.^[1] Last year alone, extreme weather events caused approximately US$320 billion in losses, of which about US$140 billion were insured.^[2] Weather-related catastrophes accounted for the overwhelming majority of both overall and insured losses. By mid-2025, insured losses had already reached around US$80 billion, with projections suggesting full-year totals could exceed US$150 billion.^[3]

The human and economic consequences may be severe, with the World Economic Forum and Oliver Wyman estimating that, by 2050, up to 14.5 million additional deaths and US$12.5 trillion in economic losses could occur as a result of climate-related disasters.^[4] Meanwhile, research from S&P Global Sustainable projects that the physical effects of extreme weather events could lead to financial impacts of up to US$25 trillion for the world’s largest companies by the middle of the century.^[5]

For investors, climate risk management could include both transition and physical risks. This is not a question of choosing between mitigation or adaptation as both are now important to help manage risks and help long-term value. Our introductory report in our new series on adaptation and resilience in investor portfolios, calls for a broader, more integrated approach. The full report, available on the Mercer Insight Community, emphasizes the need to consider not just emissions reduction but also adaptation, nature-based solutions, circular economy principles, and a fair transition for all.

Insurance market behavior can potentially provide an early warning signal, as coverage for specific climate-related perils in high-risk regions is increasingly being withdrawn or priced at prohibitive levels. This shift effectively transfers more risk to asset owners and operators, emphasizing that understanding where physical hazards intersect with asset exposure is now fundamental. 

Mercer’s Transition Pathway approach embeds adaptation and resilience across three key dimensions – risks, alignment and solutions – and is designed to help support investors in effectively managing both physical and transition climate risks across their investments. 

It aligns with other industry approaches such as the Institutional Investors Group on Climate Change’s Climate Resilience Investment Framework (CRIF), the Physical Climate Risk Appraisal Methodology (PCRAM), and the UK Climate Financial Risk Forum’s ABC Framework. The latter encourages financial institutions to aim to stay below 2°C of warming, to build resilience to current-policy warming, and to plan contingencies for more severe scenarios. In parallel, the UK’s Transition Plan Taskforce (TPT), whose disclosure frameworks now sit with the International Sustainability Standards Board (ISSB), has made it clear that future transition plans should be “adaptation-aware”, meaning they should address both decarbonization and physical risk management.

This rising demand for physical risk management comes as extreme weather events are arguably intensifying, from acute events like floods, wildfires and cyclones to longer-term pressures such as rising temperatures, persistent droughts and sea-level rise. Crucially, these risks can increasingly affect macroeconomic stability, with central banks recognizing that the effects of climate change can influence output and inflation within a two-to-three-year policy horizon. At the same time, traditional economic models may be underestimating potential losses because they often assume equilibrium recovery and fail to account for climate “tipping points”. Investors therefore need to complement quantitative models with qualitative judgement, recognizing that existing frameworks may not capture the full extent of climate disruption.

Globally, policy frameworks are now evolving to integrate adaptation more explicitly, led by the Paris Agreement’s Global Goal on Adaptation under Article 7. This objective has been advanced through the United Arab Emirates Framework for Global Climate Resilience, launched at COP28 in Dubai, which prioritizes key sectors including water, health, food systems, ecosystems, infrastructure, livelihoods and cultural heritage.

Further to this, as of late 2025, 68 countries had submitted National Adaptation Plans, including several developed economies.^[6] However, independent assessments in the United Kingdom and the European Union suggest that current efforts remain inadequate, implying that regulation will likely tighten in the years ahead. 

For investors, putting policy into practice begins with clear governance and integration of adaptation and resilience as core priorities. Portfolio-wide physical risk assessments using modelling refined within the insurance industry, particularly for real assets and critical suppliers, can provide the foundation for informed decision-making. Once this baseline is established, progress can be measured through defined indicators and regular engagement with investment managers, ensuring accountability that links incentives to potential outcomes.

While mitigation remains essential, the escalating costs of delayed adaptation, seen in the withdrawal of insurance, asset devaluation and rising climate-related disruption, underscore that adaptation and resilience has become a financial necessity in our view. 

Embedding adaptation within transition plans and directing capital toward practical resilience solutions can help investors to protect value, potentially  capture opportunity, and support a transition that is not only low-carbon but also climate-resilient.