While in the UK we are spending the summer bemoaning the seemingly relentless rain and cold, the rest of the world has been burning – in some cases quite literally. The summer has already been marred by stark scenes of orange skies in New York as a result of Canadian wildfires, mass evacuation of tourists from the wildfires in Rhodes and multiple heatwaves across Italy and other parts of Europe. 

July was the hottest month on record according to the UN, with temperatures exceeding 40°C across tracts of America, Europe and Asia. Extreme weather is no new phenomenon, but the increasing frequency of wildfires, droughts and flooding across the world in recent years has prompted many scientists to attribute these worsening conditions to climate change. 

Take Canada as an example. It is a country used to wildfires, but this year four times as much land has burned than any other season since 1990. In total, more than 20 million acres have been decimated due to an extreme dry period followed by a heatwave, leading to the ghostly scenes seen in New York and other parts of the US at the beginning of July. 

Real monetary impact of extreme weather

Extreme weather has very real consequences on our financial system; it has already made some US homes uninsurable as insurers decline coverage due to mounting catastrophic losses. Wildfires have caused more than $30bn in insured losses in California alone since 2017, according to the reinsurance company Munich Re. To put that into perspective, in two years – 2017 and 2018 – the insurance industry in California lost the equivalent of the two decades of profits they had made prior to those years. 

State Farm, one of the largest insurance companies in the US, announced earlier in the year that it would stop selling coverage to California homeowners – not just those at risk of wildfires, but everywhere in the state. The culmination of wildfires, rising sea levels and high replacement costs for homes has made California one of the most uninsurable states in the US. 

California is not alone in becoming uninsurable, with Florida, Texas, Colorado, Louisiana and New York closely following. Many of the bigger insurance providers have exited Florida due to the frequency of hurricanes and high incidences of insurance fraud. Homeowner premiums in the state are skyrocketing to almost triple last year’s national average, according to the Insurance Information Institute. 

Natural catastrophes have cost insurers $50bn in losses this year, the highest seen since 2011, highlighting the challenge the sector faces from climate change. Reinsurers are demanding much higher prices for cover of extreme weather events in response to the escalating costs. 

The pushback from insurers in high-risk areas is already being felt in Europe. It’s estimated that almost 90% of natural disaster-driven losses in Europe weren’t covered by insurance in the first half of 2023, according to Munich Re.

Unease across the insurance sector has knock-on effects for the rest of the financial system. Escalating insurance premiums quickly become unaffordable, but without insurance many banks are unwilling to lend, which means homeowners looking for a mortgage in these areas are stuck between a rock and a hard place. Uninsurable properties are generally unsellable properties, with the risk that swathes of properties in California may become stranded assets. 

This in turn hits the banks’ mortgage books. Wildfires, exacerbated by climate change, damage properties, diminishing property values and increasing the risk of delinquencies on mortgage books. This leads to reduced liquidity, resulting in tighter lending by financial institutions when subject to multiple climate shocks. The scenario described is the playbook for a number of extreme weather events – for example, rising sea levels causing flooding and damage to buildings. 

Let’s not forget there are whole economies reliant on temperate weather, not least summer holiday hot spots such as Greece, Italy and Spain, all of which have been sweltering this summer and must be worrying about the threat to their tourism industry. Meanwhile, in the Maldives and other low-lying islands, rising sea levels are an existential threat. 

Another aspect not often examined is lost worker productivity due to soaring temperatures and corresponding reductions in GDP. At high temperatures, further compounded by high humidity, people’s bodies struggle to maintain the 37C internal temperature that is essential for normal body function. 

In a small study in 2022, researchers at Loughborough University modelled the impact of heat stress on productivity during a full physical work shift and found that working at temperatures of 35°C/50% relative humidity results in an average 35% decrease in productivity throughout the workday, going up to 76% reduction when the thermometer reaches 40°C/70% relative humidity. More than one billion workers across the world already experience heat stress at temperatures in excess of 35°C.

The Adrienne Arsht-Rockefeller Foundation Resilience Centre calculated in 2021 that extreme heat costs the US $100bn a year in lost labour productivity; a figure that could double by 2030 if no action is taken. Compare that with the estimated $60bn-65bn cost of the record-breaking 2020 Atlantic hurricane season. 

Proving Malthus right…or wrong? 

Taken to its full conclusion, climate disaster risk is systemic financial risk. The Malthusian view is that in the current context, there is still capacity to absorb negative events, such as environmental degradation and global warming, but building stressors exacerbated by these events, such as droughts, heatwaves, loss of biodiversity and crop vulnerability leads to growing income inequality and ultimately, market volatility. 

From there, there can be a few sudden or gradual tipping points: displacement, water conflict, crop failure and price spikes to name a few. Ultimately, this can lead to multiple breadbasket failure: currency destabilisation, political destabilisation, civil unrest and war. 

Fortunately, there is still time for us to act. Pledges around the world for net zero are a start, but there is still much to be done in terms of transition to net zero. This is an area where the financial services sector has a pivotal macro-stewardship role to play in terms of funding and directing investment towards sustainable investments. 

Regulation, too, will be pivotal to ensuring companies operate in line with emission goals, but what we really need is a cross-coordination across countries to prioritise combatting climate change in order to reduce the likelihood of extreme weather events that have resounding repercussions on our financial systems and beyond. 

Let this not be the tragedy of the horizon – described by Mark Carney, former governor of the Bank of England, as the catastrophic impact that climate change will have on future generations, while the current generation has little incentive to act. 

Polly Tsang, ICAEW Financial Services Regulatory Manager

This article was authored by ICAEW’s Financial Services Faculty. To find out more about the faculty and to become a member, visit the faculty’s dedicated hub.