Glossary term
Physical Climate Risk
Subject: Sustainability and ESG, Climate Risk
Also known as: Physical risk
Physical climate risk is the risk of damage and loss from climate hazards, either sudden events such as floods and storms or slow shifts such as rising seas and sustained heat.
Explanation
Acute risks are discrete events: cyclones, wildfires, flash floods, heatwaves. Chronic risks build gradually: higher average temperatures, drought, sea level rise, changing rainfall. Both can destroy property, interrupt supply chains, cut worker productivity, lower crop yields and raise insurance costs. The loss to a firm depends on three things: the hazard, how exposed its assets are, and how vulnerable they are. Location data is therefore central, and a plant on a floodplain faces more than the same plant on high ground. Effects spread through the financial system: collateral loses value, borrowers default and insurers face higher claims. Analysts assess physical risk using climate models and asset-level mapping. Losses land on real assets, such as buildings and plants, that lenders and insurers hold as collateral or cover.
Example
An insurer maps the properties it covers against flood and cyclone data. It finds that 6% sit in high-hazard zones, where premiums may rise or cover may become unavailable. It reviews underwriting limits for those areas and checks what reinsurance protects against a single large storm.
Not to be confused with
- Transition Risk
- Physical risk comes from climate hazards themselves. Transition risk comes from policy, technology and market changes in moving to low carbon.