Physical risk is the potential for financial loss from the direct, tangible consequences of climate change, such as damage to assets from extreme weather or changing environmental conditions. Understanding this risk is crucial for businesses and investors to protect their portfolios and adapt to the unavoidable impacts of a warming planet.
Physical risk represents the direct financial threat posed by the physical consequences of a changing climate. As global temperatures rise, the frequency and severity of climate-related events increase, posing a direct danger to physical assets, supply chains, and business operations. This risk is a core concern for investors, corporations, and governments, as it can lead to significant value destruction, higher insurance costs, and operational disruptions. Addressing it requires both mitigating future climate change and adapting to the impacts already underway.
To properly assess and manage it, physical risk is typically categorized into two main types:
- Acute Physical Risk: This refers to event-driven hazards that are becoming more frequent or intense due to climate change. These are often sudden and severe, causing immediate damage. Key examples include hurricanes, floods, wildfires, and heatwaves.
- Chronic Physical Risk: This encompasses the longer-term, gradual shifts in climate patterns. These changes progressively alter the environment, impacting resource availability, productivity, and the viability of assets over time. Examples include rising sea levels, higher average temperatures, water scarcity, and changing agricultural conditions.
These two forms of risk are often interlinked; for instance, chronic increases in average temperatures can exacerbate the severity and frequency of acute wildfires and droughts.
Concrete Examples
- Acute Risk Use Case: A multinational corporation operates a key manufacturing plant in a coastal area. A Category 4 hurricane, intensified by warmer ocean temperatures, makes landfall and floods the facility. The company suffers millions in direct asset damage, extended business interruption, and its stock value drops due to revised earnings forecasts.
- Chronic Risk Use Case: An agricultural investment fund holds significant land assets in a region that begins experiencing persistent, multi-year droughts. Crop yields decline steadily, water costs for irrigation skyrocket, and the land's long-term productivity diminishes, leading to the asset becoming "stranded" or significantly devalued in their portfolio.
Understanding these risks is the first step. The next is taking action to accelerate the transition to a low-carbon economy, which is the ultimate solution to slowing the pace of these physical impacts. Learn more about the role of Transition Risk in the green economy. For a comprehensive framework on reporting climate risks, refer to the official guidelines from the Task Force on Climate-related Financial Disclosures (TCFD).