As climate change accelerates, physical risks are rewriting the rules of finance and exposing the fragility of financial safety nets.

For decades, the world’s financial system has relied on a basic assumption: that natural disasters, while costly, are statistically predictable and insurable. Banks lent, knowing insurance would cushion borrowers and assets in case of catastrophe. Insurers pooled risks, smoothing losses across geographies and time. But as the climate warms, this foundational logic is faltering. Today, the consequences are already rippling through balance sheets and boardrooms as they are no longer a distant reality.

Understanding Climate Risks: Acute vs. Chronic Physical Threats

Climate risk is an umbrella term encompassing a range of dangers that stem from our changing planet. At its core, it splits into two main categories: physical risks and transition risks. While transition risks involve the economic transformation triggered by policy shifts, new technologies, or changes in consumer behavior, physical risks are the direct result of shifts in the Earth’s climate system itself.

Physical climate risks are divided into two types, acute and chronic:

• Acute physical risks are linked to sudden, severe events. These are the disasters that make headlines: catastrophic floods, windstorms, wildfires, and hurricanes. They strike quickly and can cause immense loss of life and property in a matter of days or even hours.
  
  

• Chronic physical risks, by contrast, develop over longer timescales. These include rising average temperatures, prolonged droughts, gradual sea-level rise, and shifting weather patterns. Chronic risks rarely cause devastation overnight, but their relentless pressure can undermine economies and communities just as surely if not more so than acute disasters.

Both acute and chronic physical risks are already reshaping the world’s economic landscape, exposing vulnerabilities not just in infrastructure, but in the financial logic that underpins entire sectors. For banks and insurers, understanding this distinction and the interplay between rapid shocks and slow-moving stresses is now essential for resilience and long-term value creation.

Counting the Cost: The Scale of Physical Climate Risk

The mounting impact of physical climate risks is now measurable in rapidly rising economic losses. Extreme weather events and long-term climatic changes are leaving a growing financial toll across countries and sectors.

In Europe, weather- and climate-related extremes have caused average annual losses of around €17.8 billion in the 2010s and €44.5 billion for the period between 2020 and 2023, showing a significant jump in losses. Since 1980, the economic losses amounted to €738 billion for EU member countries, and the trendline points sharply upward as events become more frequent and severe (EEA, 2024).

This global trend is becoming even more pronounced. In 2024, estimates from Munich Re show that natural disasters resulted in total economic losses of approximately USD 320 billion, with only about USD 140 billion of those losses covered by insurance. These figures represent a marked increase over the average for the previous decade and the past thirty years, where total annual losses typically ranged between USD 181 billion and USD 236 billion, and insured losses averaged just USD 61 billion to USD 94 billion. This shows that both the scale of losses and the protection gap between insured and uninsured losses are growing steadily as climate extremes become more frequent and severe (Munich Re, 2025).

These figures highlight a sobering reality: as physical risks intensify, so too does the financial exposure of both public and private sectors. Importantly, only a portion of losses are insured, meaning that an increasing burden falls on households, businesses, and governments to absorb costs.

The Web of Risk: From Floods to Droughts

Physical climate risks do not manifest in isolation; rather, they are part of an interconnected web of vulnerabilities. Acute risks, like the catastrophic floods that swept through Germany and other parts of Europe in 2021 and 2024, trigger direct and immediate losses. The Ahr Valley floods, for example, caused damages estimated at around €20 billion according to DKKV, of which only about a quarter was insured (DKKV, 2022). The EEA shows a similar picture, with only about 20% of economic losses being insured across the EU member states, highlighting the profound protection gap (EEA, 2024)

But chronic risks can be equally disruptive even if often less visible. The severe drought that gripped Germany and much of Central Europe in 2018 is a stark example. That summer saw river levels drop so low that barge traffic on the Rhine was halted, disrupting supply chains and industry. The agricultural sector suffered record crop failures, and water shortages became a significant challenge. The German Insurance Association (GDV) reported drought-related agricultural losses in the billions, with many farms facing financial hardship as droughts became more persistent.

Both acute shocks and chronic stresses are deeply interconnected, often amplifying one another’s effects. Acute disasters like floods, storms, or wildfires can inflict sudden, large-scale losses, but they rarely occur in a vacuum. Often, they strike communities and sectors already weakened by ongoing pressures such as drought, heat, or shifting rainfall patterns. Chronic risks, meanwhile, quietly erode resilience over time, making economies more vulnerable to the next acute event. For banks and insurers, this web of risk means exposures can accumulate and compound across asset classes, geographies, and time horizons. It is not only the headline-grabbing disasters but also the persistent, slow-burn impacts that threaten the stability of financial portfolios and the broader economy. Recognizing and preparing for this interplay is now a critical challenge for risk management and long-term financial stability.

The Financial Industry’s Critical Juncture

The financial industry stands at a pivotal crossroads as the climate crisis reshapes the boundaries of risk and insurability. For decades, banks have relied on insurers as a safety net, assuming that risks from natural hazards could always be spread and absorbed. Yet this foundational belief is now being challenged. Allianz board member Günther Thallinger recently highlighted that rising temperatures lead to more intense and frequent natural disasters, resulting in insurances to withdraw from certain areas or hazards, simply because “the math breaks down: the premiums required exceed what people or companies can pay.” (Thallinger, 2025). This growing protection gap exposes banks and the wider financial system to increasing climate risks.

This situation is further complicated by the fact that traditional financial risk models, which are anchored in historical data, are increasingly unreliable in a rapidly changing climate. Acute events and chronic stresses are both intensifying, and past losses are no longer an adequate guide for future threats. As a result, supervisors and regulators are urging a shift toward forward-looking, scenario-based assessments of climate risk. In the EU the ECB and EBA, and in Germany the BaFin, mandate financial market participants to conduct scenario analysis on a regular basis as part of the supervisory obligations. 

The ECB and other regulatory bodies warn that failing to adapt could result in rising default rates, falling collateral values, and ultimately, systemic financial instability. The EEA further underscores how serious the situation has become. The 2024 European Climate Risk Assessment concludes that the EU is underprepared and that  adaptation is not keeping pace with the severity and frequency of extreme events.

A Call for Anticipation, Not Reaction

The message for banks, insurers, and investors is unmistakable: the era of relying solely on insurance markets to absorb physical climate risk is ending. What’s needed now is a shift to robust, forward-looking risk management and embedding climate resilience into core strategy, not just compliance. This is no longer just a regulatory requirement, but an urgent business imperative for financial stability and long-term value creation.

At Atlas, we’re ready to support this transformation. With our climate risk expertise, we help organizations move beyond backward-looking models and gain a clear, actionable understanding of both acute and chronic physical risks. Our approach empowers organizations to identify exposures, test resilience under a range of scenarios, and build effective adaptation strategies, so that they are prepared not just for the next regulatory deadline, but for the next real-world shock. If you’re ready to move from reaction to anticipation and want a partner who can help you navigate this complex landscape Atlas is here to help.