Navigating Physical Risks: Strategies for Building Resilience
Key Takeaways
- Understanding Physical Risks – Climate change drives acute risks (floods, hurricanes) and chronic risks (rising temperatures, sea-level rise), impacting businesses through asset damage, supply chain disruptions, and financial instability.
- Financial & Business Impact – Physical risks lead to operational losses, credit defaults, declining asset values, and stranded assets, affecting long-term business viability.
- Building Resilience – Companies can mitigate risks by integrating climate risk assessments into Enterprise Risk Management (ERM), conducting scenario planning, and adopting adaptive strategies for long-term sustainability.
Physical risks are the direct outcomes of environmental changes, including extreme weather events, that affect businesses, assets, supply chains, and the broader economy. These risks are categorized into two types:
- Acute physical risks: Arise from extreme events like floods, hurricanes, storms, and wildfires, which are intensifying due to climate change.
- Chronic physical risks: Result from long-term climate shifts such as rising temperatures, sea levels, altered precipitation patterns, and ocean acidification.
Factors Influencing Physical Risks
Physical risks are not solely determined by hazards; exposure and vulnerability significantly influence their impact:
- Exposure: The presence of assets in high-risk locations. For example, a factory in a low-lying coastal area is highly exposed to flooding.
- Vulnerability: The susceptibility of assets to climate impacts. A facility with flood protection measures, like pumps, is less vulnerable than one without. Vulnerability also encompasses inadequate climate change preparedness and financial resilience.
- Supply chain disruptions caused by third-party damages.
- Legal liabilities for insufficient risk preparation.
- Macroeconomic effects, like reduced regional revenues.
- Systemic risks affecting interconnected businesses.
- Lower worker productivity due to extreme heat.
Impacts on Businesses
Physical risks manifest through both direct and indirect channels:
Direct impacts:
- Damage to facilities, causing operational disruptions.
- Reduced repayment ability of borrowers due to operational losses.
- Devaluation of collateral, such as real estate, due to weather-related damage.
Indirect impacts:
- Credit risk: Defaults by borrowers.
- Market risk: Decreased asset values and property prices.
- Liquidity risk: Withdrawal of cash by customers.
- Underwriting risk: Increased insurance premiums or coverage denials.
- Operational risk: Infrastructure damage and supply chain interruptions.
Financial Risks Associated with Physical Risks
Physical risks can lead to financial vulnerabilities, including:
These risks may destabilize financial institutions, as their risk management often relies on robust insurance coverage.
Stranded Assets
Physical risks can result in stranded assets those devalued or written down prematurely due to climate-related events. Stranded assets can affect nearly all sectors, particularly in vulnerable regions.
Modelling Physical Risks
To effectively quantify and mitigate physical risks, businesses can employ physical risk modelling, which involves:
- Data Collection and Integration: Gather internal data (asset locations, historical losses) and external data (climate projections, hazard data).
- Hazard Identification: Assess potential acute and chronic climate hazards.
- Exposure and Vulnerability Analysis: Analyse asset exposure and sensitivity to identified hazards.
- Model Selection: Use macroeconomic or catastrophe models based on data needs and complexity.
- Scenario Development: Explore potential outcomes using climate scenarios.
- Risk Quantification: Translate physical impacts into financial terms using advanced analytics.
- Mitigants Consideration: Account for insurance, disaster funds, and infrastructure projects.
- Model Validation: Ensure accuracy and refine models with updated data.
- Reporting: Present findings for strategic decision-making and stakeholder communication.
- Integration with ERM: Embed insights into enterprise risk management frameworks.
By combining data, advanced modelling, and scenario analysis, businesses can anticipate climate-related impacts and enhance their resilience.
How can Endurisk Help?
Climate change and environmental shifts bring unprecedented physical risks, from extreme weather to supply chain vulnerabilities, challenging organizational resilience and sustainability. Endurisk Advisory offers comprehensive solutions to identify, assess, and mitigate these risks, empowering organizations to adapt and thrive in an uncertain future.
Key Support Areas:
- Materiality Assessments & Risk Integration: Identify critical physical risks and incorporate them into Enterprise Risk Management (ERM) frameworks, ensuring strategic focus and prioritization.
- Scenario Planning & Supply Chain Analysis: Develop risk-based climate scenarios, evaluate supply chain vulnerabilities, and design resilient adaptation strategies.
- Monitoring, Reporting, & Innovation: Implement robust tracking systems, align disclosures with established standards, and explore innovative approaches to resilience, such as sustainable strategies and adaptive policies.
Endurisk Advisory enables organizations to transform the challenges of physical risks into opportunities for resilience and innovation. With tailored strategies and expertise, we ensure businesses are equipped to navigate a climate-impacted landscape while driving sustainable growth and compliance with global standards
Author
Tauwfiq Wahidi is the founder of Endurisk Advisory, specializing in risk, sustainability and ethics advisory with over a decade of experience.
