The physical hazards of climate change, from destructive weather events to longer droughts or heat waves, are becoming more severe and more frequent. Yet many large companies around the world are not engaging in climate adaptation efforts to build resilience to these hazards, new research from S&P Global Sustainable1 shows.  This gap is emerging as one of the crucial risks facing the global economy. According to the World Economic Forum’s Global Risks Report for 2023, the failure of climate change adaptation ranks as the second-greatest risk for companies over the next 10 years.

Investments in adaptation will need to increase to cope with the rising costs from physical climate risks such as wildfires, flooding and hurricanes. According to the World Meteorological Organization, climate-related disasters are now nearly five times as frequent. If the current trend continues, the number of disasters could rise to 560 per year by 2030, up 40% from 2015. Up to $340 billion per year of adaptation finance is needed by 2030 to pay for investments in technology and in transforming agriculture and water systems.

More stakeholders across the public and private sectors are recognizing adaptation as a key part of solving the climate crisis. It was a major focus at COP27, the U.N. Climate Change Conference in Sharm el-Sheikh, Egypt, where companies and governments announced several initiatives to boost capital flows toward adaptation and raise billions of dollars in investment to protect vulnerable communities from the effects of climate change.

But while the sense of urgency around climate change adaptation is growing, many companies are moving slowly to adapt their businesses to the physical risks of climate change. Data collected in the 2022 S&P Global Corporate Sustainability Assessment, or CSA, shows that just one in five companies across sectors has a plan to adapt to the physical impacts of climate change. The CSA defines an adaptation plan as a plan to adapt to any climate risks across a company’s value chain that the company has identified through a climate risk assessment. The plans can be specific climate-related mitigation plans included in wider risk assessments, or separate climate-specific reports.

The sectors with the highest rates of physical risk adaptation planning are utilities, at just over 40%, and energy, at almost 30%, based on assessments of 6,416 companies in the 2022 CSA. Both industries are heavily reliant on physical infrastructure, which will be increasingly at risk of damage and disruption from storms, flooding and other climate hazards.

In the financial sector, less than a quarter of companies report having an adaptation plan. Banks, insurers, asset managers and asset owners are exposed to the wider economy through lending, investing or underwriting across industries, which can make them more exposed to the economic impacts of climate change — including its physical impacts. Financial institutions also play a key role in financing the transition and facilitating the flow of the trillions of dollars in capital that economists have said is needed to mitigate and adapt to climate change.

Four sectors have slower progress on adaptation planning than the cross-sector average: health care, communication services, information technology and consumer discretionary. Some of these sectors are traditionally seen as less directly exposed to physical climate-related risks yet will face significant physical risks to their assets over the coming decades, absent adaptation. Hospitals in major coastal cities may need to adapt to rising sea levels and more severe storms. Internet and cloud computing firms that rely on infrastructure such as server facilities will contend with heat waves that can interrupt operations.

S&P Global data shows that about half of the 1,375 assessed companies with adaptation plans have an implementation timeline of 10 years or sooner. About one-third of companies have already implemented at least one of their adaptation plan measures or aim to put their plan in action within five years. The other half of companies with plans, however, are not acting with urgency to prepare for physical risks. In four sectors — industrials, materials, energy and consumer discretionary — a majority of companies with plans indicated they will not take action for at least a decade or have no timeline for action.

Preparing for climate impacts, and securing the funding to pay for adaptation, is a challenge for municipalities and countries as well as the private sector. Adaptation financing lags far behind money going toward mitigation, which includes actions taken to lower emissions and limit global warming. Less than 8% of global climate finance goes toward projects aimed at building climate resilience. The impacts from climate change will not be evenly distributed, with lower- and lower-middle income countries more at risk and less ready to cope than higher-income nations. An agreement reached at COP27 for a “loss and damage” fund will seek to address adaptation and resilience challenges of developing countries. Companies can play a role in facilitating private funding.

According to the World Economic Forum, only 3% of adaptation funding comes from private sources, but climate risks could equal annual revenues of 10% for some companies. Investments in adaptation can help firms manage those risks and provide growth opportunities, WEF wrote in a white paper.

Some sectors do not see climate as a top material issue

One clue to why adaptation plans are scarce is that many companies in every sector do not consider climate strategy to be a top material issue. About 23% of companies assessed in the 2022 CSA selected climate strategy as one of their three main material topics in their assessments, and that percentage varied widely across sectors. Roughly half of energy and utilities companies see climate as a top material issue, while less than 10% of assessed health care companies do.

Yet even some of the sectors that consider climate strategy to be a primary material issue have a gap in adaptation planning. Less than one-third of energy companies have an adaptation plan despite about half of assessed companies putting climate strategy in their top three material topics. The gap is smaller for utilities, but the sector still shows a discrepancy between how companies view climate and what action they are taking to address climate risks. Nearly 50% of utilities regard climate strategy as material, but just 41% have an adaptation plan. One in three materials sector firms believe climate strategy is material, but only one in three have a plan to adapt to the physical risks.

Conversely, some sectors are taking action to develop adaptation plans despite not viewing climate strategy as a material issue. More than 17% of health care companies have an adaptation plan, but only 9.7% regard climate strategy as material. In communication services, 17.4% of companies have an adaptation plan, but only 12.9% consider climate to be material.

Climate assessments and scenario analysis

CSA data also shows that climate risk assessments and scenario analysis, which usually form the basis for adaptation plans, are uncommon in some sectors.

A climate risk assessment can show how consideration of climate-related risks — both transition and physical risks — are embedded throughout an organization, and how vulnerable an organization might be. Scenario analysis can help companies understand how climate change will impact their business and financial performance under different potential future scenarios. Companies can test for physical risks, such as rising sea levels or an increase in extreme weather events like hurricanes, flooding and wildfires. Transition risk scenario analysis takes a forward-looking approach to how future policy, regulatory and technological changes as well as legal, market and reputational risks would impact a business.

Just over 46% of assessed companies globally conduct physical risk assessments, according to CSA data. Sectors where physical risk adaptation plans are common are also those where the rate of physical risk assessment is high, reflecting the importance of understanding a company’s exposure to climate change before implementing a strategy on how to deal with climate risks. For example, nearly 71% of utilities conduct physical risk assessments, as do nearly 56% of materials firms and 50.3% of financial companies. Health care and communications services companies rank the lowest, with only around a third conducting physical risk assessments.

However, fewer companies are performing scenario analysis. Only about half of utilities undertake either quantitative or qualitative scenario analysis, or a mixture of both. Quantitative scenario analysis uses analytical models to determine a wide range of climate-risk outcomes, while qualitative scenario analysis uses descriptive narratives and is often the first step for organizations to explore potential future climate outcomes.

TCFD uptake has far to go

CSA data shows that high-emissions sectors have a higher percentage of companies integrating the recommendations of the Task Force on Climate-Related Financial Disclosures, or TCFD, which uses standardized guidelines to steer companies in disclosing material climate risks and conducting scenario analysis. Those are also the sectors that are more likely to have an adaptation plan in place.

For example, more than 70% of utilities companies are fully or partially reporting in line with the TCFD’s 11 disclosure recommendations. These recommendations include detailing management’s role in calculating and overseeing climate-related risks, as well as conducting scenario analysis to test a company’s resilience to different climate-related scenarios, including one in which the world limits global warming to 2 degrees C or lower. The goal of the 2015 Paris Agreement is to limit global warming to “well below” 2 degrees C and “preferably” to 1.5 degrees C compared to preindustrial temperatures. About 65% of energy firms assessed integrate TCFD, compared to 59% of materials and 56% of financials.

The sectors that have a low percentage of adaptation planning, as well as climate risk assessment and scenario analysis, are also unlikely to integrate TCFD recommendations. Only one-third of communication services firms integrate the framework. Health care has a similar rate, while about 40% of information technology companies are disclosing in line with the framework.

Growing regulatory pressure

Companies, particularly those based in Europe, are facing regulatory changes that will force them to take action on adaptation. The EU’s green taxonomy — a dictionary of sustainable activities designed to steer companies as they adapt their business strategies to climate change — requires companies to disclose on climate adaptation. The 11,700 firms currently subject to the EU’s Non-Financial Reporting Directive have to disclosure their taxonomy alignment, including on climate adaptation, as of Jan. 1, 2023. The number of companies having to report will expand from 2026 under a reformed version of the directive, the Corporate Sustainability Reporting Directive. Nearly 50,000 companies will be subject to the new rules.

The financial sector will also come under pressure as banking regulators step up climate stress tests, typically using scenario analysis created by the Network for Greening the Financial System, a group of central banks collaborating on how to tackle climate change.

Adaptation is becoming as important as climate transition in terms of protecting lives, assets and the productive capacity of the economy over time. Climate risk assessments and scenario analysis can give companies the foundation to implement physical risk adaptation plans that prepare them for the effects of extreme weather events on their business and the broader economy.