Why Physical Climate Risks Are Driving Up Capital Costs

Unlike most sectors, risk is not something that is avoided in the worlds of insurance and finance. In fact, the truth is quite the opposite: these sectors thrive on risk.

That, simply, is because the banks, brokers and investors get to charge a premium to clients that are exposed to risks.

And of all the risks in the world today, climate change is undoubtedly the most ubiquitous.

For years, we have seen how the insurance sector responds to extreme weather. In the US, for example, it is taken as writ that the hurricane states around the Gulf of Mexico command a far higher insurance premium than those further inland.

Now, with the effects of climate change worsening every day, those premiums are rising even more. But this spike is not confined just to insurance policies. New analysis by Bloomberg shows that companies facing climate threats are already paying a significant, measurable premium on their cost of capital.

The research, which quantifies how global markets are pricing environmental threats into corporate financing, shows that firms with 10 percentage points higher asset damage rates from climate hazards face additional 22 basis points in their average cost of capital.

What's more, that premium persists even after controlling for sector, region and company size, which suggests that markets are systematically penalising climate-exposed businesses.

"In other words: if you’re more exposed to storms, floods, or heatwaves, financing gets more expensive – and valuations take a hit," explains Niall Smith, Senior Sustainable Investments Quantitative Researcher at Bloomberg, who led the study.

Methodology uncovers hidden pricing signal

The findings represent one of the first comprehensive attempts to measure whether physical climate risk – as distinct from transition risk – carries a detectable financing cost across global equity markets.

For its analysis, Bloomberg looked at publicly listed companies worldwide, linking their physical climate exposure to financing costs through cross-sectional regression analysis.

The research used physical risk indicators developed with Riskthinking.AI, which assess potential asset damage from ten climate hazards including tropical cyclones, riverine and coastal flooding and heat stress.

The climate risk signal proved elusive in raw data, with no simple correlation visible between physical exposure and financing costs either globally or by country average.

"Initially, descriptive analysis of the raw firm-level data is unconvincing in supporting the hypothesis," the research notes.

Only through regression analysis controlling for structural factors did the relationship emerge, with the 22 basis point effect proving statistically significant at a p-value below 0.001.

Which sectors are subject to the biggest price fluctuations?

The financing penalty varies dramatically by sector, with asset-intensive industries bearing the steepest costs.

Materials companies face a 56 basis point premium per 10-point increase in physical risk, while utilities pay 45 basis points more than standard prices.

Communications firms showed a 62 basis point effect, though Bloomberg has warned that this particular finding is less statistically robust.

"This finding is quite theoretically consistent, suggesting that capital markets are attuned to the fact that asset-intensive sectors with typically higher PPE (Property, Plant & Equipment) values are more exposed to the physical impacts of climate change," the analysis states.

Other sectors showed coefficients below the global average, indicating investors differentiate between industries when pricing climate exposure.

Why are emerging markets and developing countries paying more for climate change?

The disparities are even more pronounced depending on the region. Bloomberg's analysis shows that Latin American companies face a 94 basis point premium for equivalent climate exposure – more than four times the global average – while Asian firms face 25 basis points in additional costs.

Meanwhile, the effect in developed markets appears considerably weaker.

The analysis controlled for sectoral composition, suggesting the regional differences reflect genuine geographical risk pricing rather than industrial mix.

Brazil emerged as an example where high climate exposure coincides with elevated financing costs, though Bloomberg stresses the relationship doesn't map neatly onto country averages.

"Together these results imply that markets may be pricing physical risk into financing costs, but that they're not simply applying a straightforward 'country risk premium' to firm-level WACC," the research explains.

Going forward, global climate events like the upcoming COP30 will likely dig into the details of these kinds of disparities and make some attempt to redress the balance.

As Barbara Buchner, Global Managing Director at the Climate Policy Initiative for the UN, says: “Success looks like getting people in the room who aren’t there yet and making sure everyone, from local to global levels, works together to scale private investment."

Disclosure could lower corporate financing costs

The findings carry implications for both investors and corporate strategy.

"Investors should look to fully integrate physical risk factors into valuations, discounted cash flow models, asset allocations and wider investment processes to maintain risk-adjusted returns as markets increasingly wake up to the realities of climate change," Bloomberg recommends.

For companies, the research suggests climate adaptation strategies may deliver tangible financial benefits beyond operational resilience.

"Corporates on the other hand should note that by demonstrating resilience to physical risk – through disclosure of climate risk assessments and clear adaptation plans – they may be able to lower their financing costs moving forward," the analysis concludes.