With climate events growing in frequency and cost, understanding physical climate risk is now essential to building resilient portfolios and future-proof financial plans. Dr Alejandro Martí, CEO and Co-Founder of Mitiga Solutions explains why this matters for paraplanners.
For some time now, climate risk has been viewed solely through the lens of sustainability. Investors, businesses, and regulators alike have spent time and resources tackling carbon emissions to hit net-zero targets and transition to a low-carbon economy.
These remain important considerations and shouldn’t be parked to one side. However, a different form of climate risk has emerged, and it’s one that directly impacts asset values, business performance, and, vitally, long-term investment outcomes.
As Europe enters another summer of record-breaking heatwaves and soaring temperatures, physical climate risk is rapidly moving up the agenda. What in times gone by has been viewed as a distant environmental concern has now become a measurable financial risk affecting companies, supply chains, property markets and investment portfolios.
For paraplanners and financial advisors, an understanding of these risks has become a must-have in the pursuit of successful, long-term financial planning.
How a warming world impacts finances
Physical climate risk refers to the direct impact of climate events such as extreme heat, flooding, storms, droughts and wildfires.
In the past, investors may have viewed events like this as isolated disruptions. However, the increase in both regularity and severity of extreme weather events is a clear indication that an entirely more structural shift is underway.
The knock-on economic effects of this shift are already apparent. Across Europe, climate-related events have caused hundreds of billions of euros in economic losses in the past 10 years. Operational disruptions, insurance hikes, damaged infrastructure, and general uncertainty about future direction are all having real financial consequences.
Extreme heat, in particular, remains one of the most underestimated risks. Heatwaves generate headlines, but not usually with the same urgency as flash floods or hurricanes.
Despite this, the impact of extreme heat is usually broader and more persistent. Reduced labour productivity, higher cooling and temperature control costs, disruption to transport networks, and damaged infrastructure all place a tangible strain on energy systems.
For businesses across a range of sectors, prolonged periods of extreme heat can directly impact profitability, which ultimately matters when it comes to investors.
Why investors are keeping a close eye
Due to a lack of data, insufficient technologies, and unprecedented shifts in climate behaviour, physical climate risk has historically been difficult to quantify.
Carbon footprints could be measured, but an understanding of how future climate conditions could directly impact a company’s bottom line or operational resilience was significantly more challenging.
Nowadays, financial institutions are increasingly aware of climate-related disruptions and their influence on business performance. A logistics company, for example, could see repeated disruptions if it’s exposed to a flood risk.
A manufacturer using water-dependent processes may encounter disruption during periods of drought. A commercial property in regions vulnerable to extreme heat may need additional investment to remain attractive to prospective tenants.
These are not theoretical risks; they’re real and happening every year. The result is impacted company valuations, credit ratings, and long-term returns. Now, investment analysis procedures focus specifically on physical climate risk, rather than a niche ESG consideration as in years gone by.
An evolving challenge for lenders and insurers
The implications carry far beyond just investment portfolios. Banks, insurers, and all kinds of financial institutions are also coming to terms with increased exposure to physical climate risk.
Lenders need to consider the risks of doing business with a company for which climate-related disruptions can impact repayments.
Those faced with repeated operational interruptions, skyrocketing insurance fees or declining asset values may present a greater credit risk than historical financial data would suggest.
Likewise, property markets are beginning to reflect changing climate realities. Properties situated in areas with high flood or wildfire risk may be faced with rising insurance premiums, reduced demand, or increased adaptation costs.
The insurance sector in particular is already experiencing many of these pressures. As extreme weather losses continue to increase, insurers are being forced to reassess risk exposure, price policies and, in some cases, decline to cover certain regions altogether.
This all has real significance for investors, as insurance availability often underpins the viability and value of physical assets.
Why this matters for paraplanners
Given all of the above, physical climate risk does, of course, pose challenges for paraplanners. Fortunately, however, it also presents an opportunity.
Increasingly so, clients are focused on long-term financial resilience. Retirement plans, investment portfolios, and intergenerational wealth strategies are designed around time spans of multiple decades.
This is the same period of time over which climate risks are expected to increase in seriousness.
The result is questions such as: How exposed are investment portfolios to geographies expected to be vulnerable to climate risks? How resilient are businesses to changing conditions?
Are current assumptions about performance still accurate in a rapidly changing climate?
More and more so, these considerations sit alongside more traditional measurements of risk and return. Importantly, I am not suggesting that every investment decision should be driven by climate scenarios, nor that physical climate risk by itself makes an asset unattractive.
Instead, it means recognising that climate has become another variable capable of influencing financial outcomes. Now, just as advisors assess inflation risk or interest-rate risk, physical climate risk is a factor that requires deep consideration when evaluating resilience and profitability in the long-term.
From ESG drivers to a financial reality
One of the biggest, most stubborn conceptions when it comes to climate risk is that it remains solely an environmental issue.
Environmental impact is real and important, but nowadays, in a practical, business sense, it is increasingly a business issue, a credit issue, and an investment issue.
Regulators are taking notice and moving in this direction, financial institutions are investing in climate-risk capabilities, and investors are seeking transparency around exposure and plans to become more resilient.
The core objective of financial planning has always been to help clients navigate uncertainty in the pursuit of improved resilience and protection against future risks.
As climate-related events continue to occur, they are becoming more and more economically significant. Therefore, physical climate risk is becoming a key part of the broader risk-management conversation.
What’s important now is that businesses, advisors, and investors are prepared for the impacts that are already emerging.
Those who get the best grasp on these risks early on will be best positioned to identify vulnerabilities and support long-term financial decisions.
Tomorrow’s world is uncertain. Only with proactive, forward-looking assessment can businesses best arm themselves for what is to follow.
Main image: climate risk, kelly-sikkema-_whs7FPfkwQ-unsplash
