Vicki Bakhshi
Climate Strategist
Paul Smillie
Senior Analyst, Investment grade credit
Rosalie Pinkney
Credit Research Analyst, Fixed Income
2026 has already seen record-breaking heatwaves in Europe, the US and elsewhere, refocusing attention on the human impact of changing climate conditions. As long-term investors it is fundamental for us to understand how changing weather patterns are influencing market dynamics and balance sheets.
The materiality of impact will vary by region. In the UK, one of the most significant ‘physical climate risks’ is flooding. As the average temperatures in the UK continue to climb, surface, sea and river flooding will increase. According to the UK’s Climate Change Committee (CCC) nearly seven million UK properties are in flood-risk areas today, while floods cost the UK c. £3.3bn per annum. By 2050, with 2°C of warming (which is likely), the number of properties at risk could increase by 40%, according to the CCC1.
To understand the scale of the impacts, we have been speaking to key UK mortgage lenders about risk perception and mitigation. Our conversations reveal a system under rising pressure: with the UK’s flood reinsurance scheme (Flood Re) set to phase out in 2039, we may see a structural repricing of flood risks to UK homes.
In our view, preparedness among UK mortgage lenders is uneven, and as a result flood risk management is becoming a differentiator. We also discuss the systemic nature of this topic, arguing that policymakers are a key piece of the puzzle and that a systems stewardship lens is needed to address the full scale of the risk.
Risk repricing can precede actual flooding
Climate risk is often treated as a problem of the future. But as insurers and climate models become more sophisticated and can better model future climates, risk pricing can correct before events occur. This puts mortgage lenders in a structurally difficult position. Insurers reprice annually; banks underwrite long-term mortgages.
Properties not currently considered at risk can be rapidly repriced as flood models are updated, leaving lenders holding collateral whose risk profile has shifted since origination. As a result, the assumption that property insurance is affordable today cannot be extrapolated into the future, putting more onus on banks and consumers to understand the long-term risk profiles of assets. Banks therefore need to become more sophisticated at understanding the long-term risk embedded in their mortgage books.
The Flood Re protection mechanism: is it hiding the real cost?
Flood Re is a government-backed reinsurance scheme that allows insurers to cede the flood insurance coverage of high-risk residential policies (built before 2009) to a pool, at subsidised rates. This keeps cover affordable for properties insurers might otherwise decline. As of March 2025, the scheme covered 346,200 policies, and over 660,000 properties have benefited since its inception.
The critical point is that Flood Re was never designed to be permanent. It is legislatively mandated to cease operations by 2039, at which point the true cost of flood risk should be reflected in insurance pricing, and by extension, in house prices. The assumption behind the scheme’s design was that flood risk mitigation measures would be in place by 2039, protecting vulnerable properties. However, this is not currently where we are heading: according to the CCC a sustained investment of £1.6-2.2bn per year is required to keep flood risk levels the same as they are today, and much more to mitigate risk completely. Government will be discussing the potential extension of Flood Re this year.
The risk to the consumer and financial stability
The risk to consumers is stark: if insurance becomes unavailable, this will leave increasing numbers of homeowners unable to access normal mortgage rates and force them onto more costly standard variable rates. According to a 2026 UKSIF-commissioned report 430,000 mortgaged homes in England could become effectively trapped by 2050, unable to sell, remortgage, or access affordable insurance due to flood exposure2. That is roughly the size of Birmingham.
In the UK housing is the primary store of wealth for most households. A structural repricing of flood-risk properties is therefore a household balance sheet issue with direct implications for consumer spending, retirement security, and financial stability. The UKSIF report warns that in a worst-case scenario, market shocks could “cascade through the wider financial system, posing a risk to overall financial stability.”
For banks, physical risk management is a growing differentiator
The systemic risk is clear. What is less clear is whether the institutions most exposed to it are prepared. As part of a broader engagement exercise with UK and European banks, assessing how climate risk is integrated into core operations and lending decisions, we found that physical climate risk management remains the weakest link across the sector.
On climate transition, banks have made genuine progress in the last few years. Public disclosure has converged around best-practice frameworks, and many banks can demonstrate how transition risk influences underwriting and lending decisions. The most advanced banks can evidence turning away business on heightened transition risks. In our view, this willingness to refuse climate-exposed transactions is now a tangible marker of operational maturity.
Physical risk, however, tells a different story. Most banks have not yet developed comprehensive frameworks for assessing how the physical impacts of climate change affect the quality of their loan books.
In the context of UK flood risk, this is particularly obvious. Our conversations with UK mortgage providers reveal a widening gap. Most banks and building societies have undertaken stress test exercises. However, only a smaller number could articulate strategies for identifying flood-exposed mortgages and incorporating flood risk into lending decisions. In our view this is a growing differentiator. Institutions that map exposure at postcode level are building a risk management advantage that will grow; those that are not will be accumulating an unquantified liability.
The 2039 date for phasing out Flood Re is not a distant policy question. Without clarity on Flood Re’s future, banks will have to take greater ownership in pricing future risk and may have to start re-pricing or refusing mortgage lending in high-risk areas today. In fact, some banks we spoke to already refuse lending in areas of very high risk on the grounds that these properties will not be able to receive manageable insurance solutions. As we see it, the differentiation lies in execution, and in the UK mortgage market, execution means knowing, at the postcode level, what your collateral is worth in a potential world without Flood Re.
The role of policymakers, and the case for system-level engagement
The cost of managing flood risk will fall between banks, consumers, private investors and governments. Sourcing £1.6-2.2bn per year in mitigative costs will be challenging and requires cross-institution work. To understand the future policy landscape, we spoke with policymakers. This included officials at Defra, the UK’s environment department, as well as a range of policymakers convened by the Climate Financial Risk Forum (CFRF), including representatives of Defra, Flood Re and the Environment Agency.
These conversations revealed that Flood Performance Certificates (FPCs) (modelled on Energy Performance Certificates) are emerging as the central household-level policy instrument. Work on the design of FPCs is well advanced, and in early July Flood Re announced the launch of a pilot scheme, working in partnership with insurers and lenders.
Over time, FPCs could create winners and losers in the property market, with direct implications for valuations, insurance pricing, and housebuilders in high-risk areas. Policymakers hope that FPCs will incentivise consumers to invest in household-level flood mitigation, rewarded with lower risk pricing.
"By far the biggest benefit of a Flood Performance Certificate (FPC) framework is that it enables individual householders to understand their flood risk, reduce it and then demonstrate the protection to others... it is only through engaging and empowering householders that we can achieve the reductions in flood risk we all need to make as climate change increases the volatility of our weather" 3
In our view, banks have a responsibility to price forward and signal to consumers where risks sit, while the government has a responsibility to manage a transition from Flood Re in a way that does not leave households stranded. The UKSIF report’s central recommendation, that the government confirm Flood Re’s future by the end of this parliament, is one we would echo. However, we do need a solution for how an extension may continue masking real risk prices and drive behaviour away from consumer mitigation. To balance these demands, ongoing engagement across investors, banks, government and the public is needed.
The bottom line
For investment managers, the implications are clear: the institutions that are treating flood risk as a future problem are accumulating a liability that may eventually become visible on their balance sheets. It is therefore up to asset managers to assess which banks and financial institutions are best able to manage the growing risk and take this into account in the way they analyse the overall risk profile of these entities.
