Overview
Physical risks are what happens when the climate itself changes in ways that damage people, property, infrastructure, and ecosystems. They are distinct from transition risks, which arise from the human response to climate change. Physical risks are already happening, they are not a future scenario.
The field divides them into two types. Acute risks are sudden, event-driven: a hurricane, a flash flood, a wildfire, a heatwave. They can destroy assets, disrupt supply chains, and trigger large insurance losses in a matter of days. Chronic risks build slowly over years or decades: rising sea levels, prolonged drought, shifting agricultural zones, increased average heat stress. They are less dramatic but often more economically significant because they structurally undermine asset values and productivity over time.
Both types carry direct and indirect financial consequences. Direct damage means physical harm to assets, a flooded factory, a coastal property made uninsurable, infrastructure rendered unusable. Indirect impacts ripple through supply chains, labour markets, and credit systems. A drought in one region can raise input costs for manufacturers thousands of miles away. A port repeatedly disrupted by storms becomes a systemic risk for logistics networks.
Physical risks are driven by temperature. The higher the warming, the worse the impacts, which is why The 1.5°C Threshold matters so much to risk professionals. Beyond 1.5–2°C, some physical impacts become impossible to adapt to, crossing what scientists call adaptation limits.
Financial Implications
Lenders, insurers, and investors are increasingly required to assess physical risk exposure in their portfolios. The TCFD framework, now embedded in legislation across multiple jurisdictions, specifically asks companies to disclose how physical risks affect their business under different climate scenarios.
Stranded Assets are one of the most visible financial outcomes of physical risk: assets located in flood zones, coastal areas, or regions facing chronic heat stress can lose value suddenly and permanently. The insurance sector is already retreating from high-risk geographies, leaving assets effectively uninsurable, which in turn affects mortgage lending and property valuations.
Supply chain disruption is an underappreciated indirect channel. The 2011 Thailand floods caused an estimated $45 billion in economic losses and disrupted global hard drive production for over a year, a relatively contained event with cascading financial effects.
Physical vs. Transition Risk Trade-Off
Physical and transition risks pull in opposite directions in terms of timing. Aggressive emissions reduction reduces long-run physical risks but accelerates near-term transition costs. Delaying action reduces transition risk today but increases physical risk severity later. This trade-off is central to Climate Finance strategy and sits at the heart of debates about optimal climate policy pathways.
The severity of physical risks is path-dependent on temperature trajectories. This is why the difference between 1.5°C and 2°C of warming is not merely symbolic, it represents a meaningful divergence in the financial risk landscape.