Physical Risk — Definition and GHG Accounting Context
Transition risk asks what the shift to a low-carbon economy will cost a company. Physical risk asks a blunter question: what will the changing climate itself do to its factories, fields, supply lines, and people?
It is the half of climate risk that a company cannot escape by cutting its own emissions — because it is driven by the world’s cumulative warming, not any single firm’s footprint.
Physical risk is the risk to a company’s assets, operations, and value chain from the physical effects of climate change. It splits into acute risk (event-driven hazards such as floods and storms) and chronic risk (long-term shifts such as heat, drought, and sea-level rise), and is assessed using physical scenario analysis.
What physical risk means
Physical risk is the risk of financial loss and operational disruption arising from the physical effects of a changing climate — the direct damage and indirect knock-on effects of climate hazards on a company’s own assets and across its value chain.
It is one of the two categories of climate-related risk, alongside transition risk, in the taxonomy the TCFD established and that IFRS S2 and the EU’s ESRS E1 now require companies to disclose. Physical risk manifests as damaged facilities, interrupted production, disrupted logistics, reduced agricultural yields, water scarcity, higher insurance and operating costs, and lost labour productivity in extreme heat. It reaches a company both directly — its own sites and people — and indirectly, through suppliers, customers, and infrastructure it depends on.
Physical risk is a risk-and-resilience concept, not an emissions-measurement method. It sits in the same climate disclosure as the greenhouse-gas inventory but describes exposure to the climate’s effects, not the size of a company’s own emissions. The two are assessed together yet answer different questions.
Acute vs chronic physical risk
Physical risk divides into two kinds that differ in tempo, and a complete assessment covers both.
Acute physical risk
Event-driven and episodic — the risk from discrete climate hazards such as floods, storms, wildfires, and heatwaves. Climate change raises their frequency and severity. The financial signature is sudden: asset damage, downtime, and supply-chain shocks.
Chronic physical risk
Gradual and long-term — the risk from progressive shifts such as rising average temperatures, sea-level rise, changing rainfall, and prolonged drought. Largely locked in by past emissions; the financial signature is a slow grind of rising costs and falling productivity.
| Acute physical risk | Chronic physical risk | |
|---|---|---|
| Nature | Event-driven, episodic | Gradual, long-term |
| Examples | Floods, storms, wildfire, heatwaves | Rising temperature, sea-level rise, drought, water stress |
| Typical impact | Asset damage, downtime, supply shocks | Rising costs, lower yields and productivity, resource scarcity |
| Time profile | Rising frequency and severity | Progressive and largely locked in |
Hazard, exposure, and vulnerability
Physical risk is not the hazard alone. It emerges only where three elements coincide — a framing drawn from climate science and used in serious risk assessment.
- Hazard — the climate peril itself and its intensity, such as a one-in-100-year flood or a threshold heat event.
- Exposure — the assets, people, and operations located where the hazard occurs.
- Vulnerability — how susceptible those exposed elements are, and how little adaptive capacity they have to cope.
Risk = hazard × exposure × vulnerability. A severe hazard creates no risk where nothing is exposed, and no risk where the exposed asset is fully protected. This is why adaptation — flood defences, cooling, diversified sourcing — reduces physical risk by cutting exposure or vulnerability, even though it cannot change the hazard.
Physical risk vs transition risk
The two climate-risk categories are often assessed side by side but behave in opposite ways across scenarios — a contrast at the heart of climate scenario analysis.
| Physical risk | Transition risk | |
|---|---|---|
| Source | The changing climate itself | The shift to a low-carbon economy |
| Worst in | High-warming scenarios | Rapid-decarbonisation scenarios |
| Underlying driver | Cumulative global emissions | Policy, technology, market, carbon price |
| Link to own footprint | Largely decoupled | Directly tied to emissions |
| Assessed via | Physical scenario analysis | Transition scenario analysis |
The inverse relationship matters: cutting emissions fast raises transition costs in the near term but limits physical risk over the long term, while a slow transition does the opposite. A resilient strategy therefore has to be tested against both a rapid-decarbonisation world and a high-warming one — which is exactly why disclosure frameworks ask for more than a single scenario.
Physical risk and GHG accounting
Physical risk has a counter-intuitive relationship with a company’s greenhouse-gas inventory: it is largely independent of it. A firm’s physical exposure is set by where its assets sit and how much the planet warms — a function of the world’s cumulative emissions — not by the tonnes of CO₂-equivalent in its own Scope 1, 2, and 3 accounts. A low-emitting company on a floodplain can carry severe physical risk; a high-emitting one on high ground may carry little. This is the mirror image of transition risk, which scales directly with a company’s own footprint.
The two still travel together in disclosure. Under IFRS S2 and ESRS E1, physical risk is reported in the same climate statement as the emissions inventory and the transition plan, and it is quantified through physical scenario analysis using high-warming pathways. Because a topic can be material to the company’s value and to its stakeholders at once, physical risk is a classic case where both sides of double materiality apply. For banks and insurers, the exposure aggregates across the portfolio, sitting alongside financed emissions in the overall climate risk picture.
Worked micro-example
A food manufacturer assesses acute physical risk to its only flour mill, which sits on a river floodplain and supplies 30% of group output.
| Element | Assessment |
|---|---|
| Hazard | Major river flood, today a 1-in-50-year event, projected toward 1-in-20 by 2050 under a high-warming scenario. |
| Exposure | The mill plus 30% of production capacity — single site, no redundancy. |
| Vulnerability | No flood defences; ground-floor electricals; just-in-time inventory. |
| Conclusion | Material acute physical risk — rising hazard × concentrated exposure × high vulnerability. |
The company’s own emissions do not change this picture. What reduces it is adaptation — flood barriers (lower vulnerability) or a second mill elsewhere (lower exposure) — not decarbonisation of the mill.
Common mistakes
- Assuming cutting your own emissions reduces your physical risk. Physical risk tracks global warming and asset location, not your footprint. Decarbonisation addresses transition risk and collective long-term warming, not your near-term flood or heat exposure.
- Assessing only acute hazards. Chronic risks — heat, water stress, sea-level rise — are slower but often larger and more certain, and they are easy to overlook.
- Treating the hazard as the risk. Without exposure and vulnerability there is no risk; ignoring adaptive capacity overstates or understates it.
- Stopping at the fence line. Much physical risk is indirect — in suppliers, logistics, and shared infrastructure — so an own-sites-only view misses the value chain.
- Using a single, benign scenario. Physical risk is surfaced by high-warming pathways; testing only a low-warming world hides it.
Screen and report your climate-related physical and transition risks.
Frequently asked questions
Physical risk is the risk to a company’s assets, operations, and value chain from the physical effects of climate change. It is one of the two climate-risk categories alongside transition risk, and covers both acute hazards (floods, storms, wildfire) and chronic shifts (heat, drought, sea-level rise). Frameworks including TCFD, IFRS S2, and ESRS E1 require it to be disclosed.
Acute physical risk is event-driven — discrete hazards such as floods, storms, and heatwaves whose frequency and severity climate change increases. Chronic physical risk is gradual — long-term shifts such as rising temperatures, sea-level rise, and drought. Acute risk shows up as sudden damage and downtime; chronic risk as a slow rise in costs and fall in productivity.
Not directly. Physical risk is driven by the world’s cumulative warming and by where your assets are located, not by your own footprint. Cutting emissions reduces transition risk and contributes to limiting long-term global warming, but a company’s near-term physical exposure is reduced through adaptation — flood defences, cooling, diversified sourcing — not decarbonisation.
Through physical scenario analysis using high-warming pathways (such as IPCC high-emissions SSPs), combined with the hazard–exposure–vulnerability framing: identify the climate hazards, locate the exposed assets and operations, and assess how vulnerable they are. The result feeds the resilience assessment required under TCFD, IFRS S2, and ESRS E1.
They are the two categories of climate risk and move in opposite directions across scenarios. Physical risk is worst in high-warming futures and is largely decoupled from a company’s own emissions; transition risk is worst in rapid-decarbonisation futures and scales with the company’s footprint. Both must be tested, which is why frameworks require more than one scenario.