Catastrophic events in an uncertain future: A pending $41 trillion bill for businesses and governments to resolve

Authors:

• Viola Lutz - Head of Physical and Transition Risk Center of Excellence, Moody's
• Chris Lafakis - Director of Economic Research, Moody's Analytics
• Kamile Rudaviclute - Asst Director Risk Management, Moody's
• Jake Carr, Director, Moody's
• Richard Loeser, Director, Moody's
• Caroline Binkley, Assc. Director, Moody's
• Elisa Loy, Asst. Director, Moody's
• Isabel Llorente Garcia, Assc. Director, Moody's

From damage to impact: A glimpse into natural catastrophes from physical risk in 2050

Analysis from Moody’s estimates that in 2050, the global economic impact of physical risk may reach $41.4 trillion, or a 14.5% loss in gross domestic product (GDP). Roughly two-thirds of this economic loss could be attributed to chronic factors such as sea level rise and productivity loss, with the remaining third attributable to more frequent and severe natural disasters.

The US faces economic losses of 9.5% of GDP by 2050, or $6 trillion. Moreover, on average, the annual damage costs from US natural disasters could be 26% higher in 2050 than in 2020. Within the corporate landscape, Moody’s estimates a 2.0 percentage-point reduction of operating margins, which is equivalent to total damages of $1.5 trillion. A typical commercial real estate (CRE) loan portfolio could see a near 18% increase in default probability and about a 20% increase — more than $200 million — in expected losses.

In this white paper, Moody’s offers perspective and a potential framework for better understanding the impacts of catastrophic events from physical risk in 2050. Starting with the big picture, we outline the macroeconomic impacts of the damages in terms of potential global GDP reductions. We also offer an approach to evaluating the damages of physical risk on real assets, which underpins the insight you need for business decisions. The results, as a pair of case studies, offer balance sheet perspectives in terms of potential credit impacts for corporates and an illustrative CRE loan portfolio.
 

The need for understanding: Navigating uncertainty and potential shifts in business impact

The long-time horizon of evolving climate risk and its associated uncertainty challenges leaders to think through new approaches on how to assess whether the impacts will be material, how they will affect global and local economies, and ultimately how they should inform and transform current practices in balance sheet management.

While contemplating physical risk in the long term may seem abstract, we have illustrations today of major catastrophes that provide a baseline for understanding the economic and financial impacts. From the wildfires in Los Angeles to the heat waves in Europe, physical risks are manifesting in catastrophic events with material direct and indirect impacts.

The global natural catastrophes of 2024 caused approximately $320 billion in economic losses and around $140 billion in insured losses according to MunichRe. These results mean that 2024 was the fifth consecutive year of global insured catastrophe losses over $100 billion. Zooming in to the Los Angeles wildfires as an example, Moody’s RMS™ Event Response estimates insured losses from $20 billion-$30 billion.

The best available science and assessment of current policy scenarios suggest even bigger and more frequent disasters as we look further into the future. Moody’s has modeled this evolving physical risk for more than 30 years with rigor and accuracy that insurance regulators have accepted as instrumental in rate filings, demonstrating our ability to develop bottom-up assessments for use cases beyond risk screening to informing business models and strategies. Since 2021, we have extended our modeling approach to offer forward-looking analytics on the evolving physical risks to 2100.

We integrate this insight into our macroeconomic scenarios and credit models to shape an outlook for 2050, which can facilitate important discussions on risk management, adaptation, and resilience planning. Institutions can utilize this new understanding of long-term physical risk in decisions that shape their financial health and uncover opportunities for innovation. The economic and financial perspective on physical risk can help inform new approaches in risk transfer and strategy by offering a common language of risk across the financial sector from insurance to banking to private credit and the public sector.

The big picture: Estimating macroeconomic impacts

Moody’s estimates that if no new transition policies are implemented, the macroeconomic impact of physical risk will total $41.4 trillion, or a 14.5% global GDP loss, by 2050. This is a comprehensive estimate that includes the impacts of both acute (flooding, heat waves, tropical cyclones, wildfires) and chronic (productivity loss, heat stress, sea level rise, agricultural disruption) physical risk. This estimate is consistent with the current policies scenario put forth by the Network for Greening the Financial System (NGFS), a collective effort by the world’s foremost central banks.

Since there are no transition policies in this scenario, the cost is purely the result of acute and chronic physical risk. Moody’s estimates that roughly two-thirds of this economic loss could be attributed to chronic factors such as sea level rise and productivity loss, with the remaining third attributable to more frequent and severe natural disasters.

These are comprehensive estimates of economic loss that consider both direct and indirect effects. Direct effects include instances such as production facilities being damaged, destroyed, or taken offline by a natural disaster. Indirect effects include but are not limited to higher heat stress weighing on the productivity of outdoor workers in industries such as construction and agriculture. Indirect effects can meaningfully alter a region’s long-term economic outlook in the following ways:

• Labor productivity: Extreme heat impairs outdoor work, reduces cognitive function, and increases health risks, leading to lower output and higher healthcare costs. 
• Migration and urbanization: Physical risk-driven displacement may swell city populations, fueling housing shortages and social tensions while abandoned rural areas face economic decline. 
• Government finances: Increased disaster recovery spending and loss of tax base in affected areas will pressure public budgets, raising the risk of fiscal distress. 

Direct effects can be equally debilitating to local economic performance. Evidence from recent Moody’s research suggests that the economic fallout from a Category 5 hurricane making landfall in Miami, for instance, would surpass that of a typical recession as long-term population loss and permanently higher insurance costs take hold. Regardless of the policy response, job losses, declining housing values, depletion of household wealth, and increased out-migration become likely baseline outcomes. In Southeast Florida, for instance, the regional economy risks long-term contraction dependent on policymakers’ actions.

Modeling damage: Distinct approach underpinning projections of 2050 costs

Macroeconomic impacts are an essential lens to understanding the broader effect from natural catastrophes to changes in weather patterns. To build a more intuitive comprehension of what might be happening in economies in 2050 from the perspective of physical risk, it is important to also look at the effects of physical risk in terms of damage to real assets and business interruption.

Moody’s evaluated the physical risk impact in 2050 across perils in the US as a complement to the macroeconomic analysis. It also serves as an input into the credit assessments.
One of the key metrics physical risk analytics deliver is the annualized damage rate (ADR). The ADR estimates the average expected damage per year, expressed as the ratio between annual damage cost and the total value of the assets exposed. It allows decision-makers to understand the expected impact from physical risk in a given year in aggregate or per peril, helping them focus on areas and assets that are most at risk.

For this analysis, Moody’s presents the change in ADR between the baseline, which is 2020 Representative Concentration Pathway (RCP) 4.5 and 2050 results under RCP8.5. [1]
 

Figure 1 Percentage change in US ADR from baseline to RCP8.5 2050 [1] Moody’s exposure considers residential, commercial, industrial, and agricultural real assets but not infrastructure

Heat stress and water stress metrics have also been considered in downstream analytics. The ADR for these chronic perils is representative only of business interruption, whereas acute perils also consider physical assets and are not included in the previous graph. Moody’s flood modeling includes hurricane-induced precipitation, whereas the hurricane component demonstrated here includes the wind component only, with surge damage ratios included under sea level rise.

This analysis underpins the financial assessments in the following section. Note that our models demonstrate how each peril may evolve over time to reflect changes in risk frequency and intensity, as well as vulnerability and exposure at the real-asset level. By assessing both vulnerability and exposure, we provide more extensive inputs for our assessment of credit impact and valuable results for considering opportunities for innovation in market needs such as insurance, risk transfer, and financing adaptation and resilience.

The financial lens: Understanding balance sheet impacts

The economic impacts give a comprehensive perspective of the impacts from extreme weather via direct and indirect channels and effects. While it is useful to understand broader dynamics and the context in the economy, decisions often need to be made at the firm and property level. To showcase the possible analytical insights, we include a case study on a US corporate credit and an illustrative CRE loan portfolio.

Impact on credit: A US national perspective and a case study on a CRE loan portfolio

Moody’s integrates physical risk directly into our credit assessments to inform how the risk of loan defaults and asset write-downs may increase for exposed entities. We incorporate the ADR to begin the assessment of potential long-term impact on credit and go one step further to account for uncertainty in the long-term view and volatility in average damages. Moody’s incorporates the standard deviation measure with the ADR to evaluate each risk and uncover impact variance even when the ADR is the same. This highlights locations with rare, high-severity events that can drive substantial financial losses.

Locations with higher ADR values see, on average, greater cumulative annual impacts from event occurrences than facilities with lower ADR values. The standard deviation of the ADR indicates the variability and uncertainty around the ADR. It is used to measure volatility in ADR year on year and can be used to compare different locations, with a higher standard deviation indicating higher risk volatility.

Corporates case study: US impacts

Moody’s estimates that under RCP8.5 physical risk events will reduce the aggregate operating margin of US companies by 2.0 percentage points in 2050, of which 1.47 percentage points represent an indirect impact driven by lower GDP and 0.56 percentage points are the direct impact that firms suffer due to the locations of their facilities. Extrapolating from our sample, which accounts for 10% of US corporate revenue in 2024, total US damages in 2050 are estimated to be $1.5 trillion.

The aforementioned figures reflect the analysis of a sample of 639 publicly listed US companies, each with over 90% of materiality-weighted facilities located in the US. The sample is broadly distributed across industries, with business services, banks, and oil and gas exploration accounting for the largest shares. The analysis reflects ADR plus one standard deviation (all perils except earthquakes) under RCP8.5 to assess direct damages and GDP reduction from the NGFS Phase 5 Current Policies Scenario to quantify indirect damages.

Direct damages affect organizations because of the specific locations of their facilities and associated exposure to both acute and chronic physical risk perils as estimated via ADR. We observe significant variation in the direct damage impact across companies, with roughly a quarter of organizations experiencing a small impact of 10 basis points or less of operating margin, but also 27% of firms strongly affected by an operating margin reduction of 100 basis points or more. Profitability impacts of this magnitude represent a significant financial challenge to companies, hurting their ability to service debt, fund growth, and return value to shareholders.
 

Figure 2: Median operating margin impact for selected nonfinancial sectors

There is variation in the direct impact of physical risk on operating margin in 2050 across sectors. Figure 2 presents the median impact for a number of selected noncorporate sectors. A sector is strongly affected either because companies’ facilities locations are vulnerable to physical risk perils (such as consumer products and chemicals) or because firms have high ratios of tangible fixed assets to sales (like utilities and mining).

The impact of physical risk also has implications for organizations’ creditworthiness. We estimate probabilities of default (PDs) for 2050 for each company, incorporating both the impact of physical risk and a counterfactual baseline without physical risk, and find significant differences. Calculating the impact of physical risk on 2050 PDs for each firm and then examining the average in the sample, we find that the average impact is a PD increase of 74%.

Illustrative CRE loan portfolio case study: US impacts

Moody’s also explored the potential credit impacts of physical risk in 2050 for a representative portfolio of CRE loans. In aggregate, the results show a potential 17.8% increase in default probability and a 22.1% increase in expected losses across the portfolio when comparing baseline credit risk metrics with physical-risk-adjusted measures. The expected loss rises from a baseline of $1.21 billion to just over $1.48 billion under an aggregate physical risk and transition scenario (with all perils combined).

Figure 3 Portfolio expected loss estimates

With a total outstanding balance of just over $62 billion, the robust portfolio under consideration consists of a set of healthy loans (with solid loan-to-value ratios and strong debt service) collateralized by geographically diverse properties across all major CRE sectors (multifamily, office, retail, industrial, and hotels). The analysis conducted here incorporated the impact of damages from natural disasters (based on the same ADR plus one standard deviation assumptions as mentioned earlier) to bottom-line net operating income and, consequently, collateral valuations; this has corresponding implications for the healthy loan-to-value ratios and debt service coverage ratios that these loans are built upon. Similar to the previously mentioned corporates case study, this analysis also leveraged an assumed macroeconomic outlook based on the NGFS Phase 5 Current Policies Scenario.

Figure 4 Expected loss rates for select metropolitan areas

The type of credit deterioration displayed here can have notable implications on the lender’s capital allocations, and while those numbers are notable in their own right, these are aggregates across the whole portfolio. Drilling down to specific metropolitan areas shows that physical risk impact can be more problematic in localized geographies as explored in additional Moody’s research . For example, looking at the subset of the portfolio with loans underwritten on properties located in New Orleans reveals that the probability of default rises by just over 43% when comparing the baseline scenario results with an aggregate physical risk scenario (incorporating impacts from natural disasters such as floods, hurricanes, wildfires, and sea level rise). The expected loss is almost 62% higher under the aggregate physical risk scenario compared with the baseline scenario. Locally, the combined exposure to those perils in the New Orleans metropolitan area creates elevated physical risks that translate into more severe credit risk than what is observed in the aggregate portfolio, which consists of loans with collateral scattered across the country. The impact of geographic diversification can be a powerful mitigant to those risks.

Decoding physical risk to uncover opportunity

Moody’s assessment of the global macroeconomic and US credit market impacts from physical risk in 2050 demonstrates a material threat that leaders must understand and incorporate into business-as-usual risk management strategies. Hurricanes in Florida or wildfires in California can be viewed as indicators, demonstrating impact and the emerging need for forward-looking physical risk modeling as events are projected to become more frequent and severe, resulting in more significant economic and financial effects.

For executives, this means acquiring tools to flexibly assess one’s risk profile. Moody’s provides such tools that allow for stress testing of portfolios against a range of plausible futures, identify hot spots for risk or opportunity, and adjust plans as new scenarios emerge. Decision-makers can also evaluate the materiality of their exposure to physical risk today into the midterm and better understand how most material risks change over time. As we look ahead, the challenge is clear, but so is the path forward: Identify and quantify interconnected risks, embrace innovation, and invest in resilience.

[1] Moody’s exposure considers residential, commercial, industrial, and agricultural real assets but not infrastructure