Reframing of climate risk and why it can't wait

Every year, the arrival of cherry blossom in Japan signals the start of spring. Given the cultural significance and beauty of the hanami festival and its short time span, forecasts for its date each year are closely tracked and widely followed.

Records stretching back 1,200 years inadvertently provide a wonderful climate change record; a millennium of relative stability until the Industrial Revolution, followed by a notable and accelerating shift to earlier and earlier blossoming.

Source: Our World in Data

Other recent climate change data is even starker: the last ten years have been the warmest on record globally, with Europe the fastest-warming continent. 2024 was the first calendar year in which average temperatures exceeded 1.5°C above pre-industrial levels.

A flawed company playbook

So what does this mean in the corporate context? A typical corporate climate change response, often driven by reporting requirements and regulations, follows a four-step process:

1. Define and measure the corporate carbon footprint

2. Undertake a climate risk assessment

3. Identify decarbonisation levers and define carbon targets, and

4. Action those targets within operations, via suppliers and through product or service changes

A common maturity profile, driven by market and regulatory requirements

Source: CEN Group

But, this sequence is fundamentally flawed. The climate risk assessment is often treated as a "necessary hurdle" before moving on to the more proactive and positive task of target-setting and net zero delivery.

The common approach overlooks that there are two elements to climate change management: companies must both align to net zero and continuously combat the inevitable impacts of climate change.

For many companies, the cost of managing those inevitable impacts may well exceed the cost of aligning to net zero, and there is a real risk that globally, the understanding and management of climate risks are inappropriately overlooked.

Climate risk costs

The frequency and costs related to extreme weather events are skyrocketing. Economic losses related to these events are tracked across the EU and US, where the costliest events are historically tropical cyclones (US) and floods (Europe). These disasters increase operational expenses, result in lost revenues due to business interruption and result in costs to repair damaged assets.

And the price tag?

• Over US$3.6 trillion in damage since 2000 has been related to climate-related disasters

• Costs are accelerating; US$1 trillion of that damage occurred between 2020 and 2024 alone

• Looking ahead, S&P models predict that annual costs for the S&P Global 1200 will reach US$1.2 trillion, absent of adaptation measures and adjustment for future inflation

The top-down estimates are confirmed by the Network for Greening the Financial System (NGFS) which estimates that, under a current policies scenario, climate change will result in an estimated 15% reduction in global GDP by 2050. That is commensurate with the current share of the US economy in global GDP, and notably, it excludes associated impacts of climate change such as human health, conflict driven by migration or resource constraint, and nature-driven risks.

When translated to company level, depending on sector, climate impacts are expected to put 5% to 25% of EBITDA at risk by 2050.

Four critical mistakes that undermine corporate resilience

The overall concern is that climate-related risks have not been given enough airtime in companies.

1. Shallow analysis and quantification.

There is a stark disparity between the prior top-down estimates and businesses' bottom-up assessments of how climate change may impact them. While 72% of companies reporting to CDP in 2024 identify climate risks that could substantively impact their business, the quantified impact on EBITDA that most sectors report is just 2% or below. Climate risks are simply not being sufficiently analysed or quantified.

2. The myth of “one and done”

The belief that a climate risk assessment is done and does not require revisiting is dangerous. Climate science is still very new, meaning that tools and estimates are continuously being revised as understanding develops. Furthermore, climate conditions are accelerating, and the policy response over the last few years has been inadequate, so models and baselines created just a few years ago are already out of date. Climate fatigue or political aversion may contribute to the reluctance to redo analyses, but regardless of the cause, risks need continued assessment.

3. Misunderstanding results

The understanding of climate change 10 years out or more can be at odds with embedded short-termism associated with the typical corporate forecast or budget period. For instance, flood risks are commonly presented as return periods, such as a 1-in-100-year event. This does not mean a flood occurs only once per century, but that there is a 1% chance of occurrence in any particular year. Whilst those odds seem slim, compounding the risk over a longer horizon results in significant probabilities: 9.6% over 10 years or 18.2% over 20 years. A one-in-five chance of a flood occurring at some point within the next 20 years sounds drastically different to a 1% annual risk.

4. The danger of relying on insurance

Companies frequently cite insurance for asset damage and business interruption as mitigation against climate risk. This confidence is misplaced.

Data indicates that the global protection gap against natural catastrophes was 43% in 2024, according to Swiss Re; i.e., so less than half of the global economic losses related to natural disasters were insured.

Furthermore, insurers get even more uncomfortable when you fold in two features of climate change:

• Unlike historic financial crises, climate risk is not cyclical. There is no bounce back to the mean and the risk is accelerating

• Some climate change risks cannot be transferred or minimized through adaptation

Insurers are already pulling back from high-risk regions. For instance, Allstate and State Farm both stepped away from the California home insurance market due to wildfire risk and even parts of the UK are at risk from being uninsurable from floods.

The insurance situation has grave systemic risks. Günther Thallinger of Allianz recently warned that global temperatures are fast approaching levels where the financial system will break down and the risk of climate-driven market failure was highlighted further by the Financial Times (“How the next financial crisis starts”).

Time to wake up

Whether stemming from shallow analysis, a misunderstanding of probability, or the mistaken belief that historic, outdated models are sufficient, businesses are failing to fully evaluate their climate exposures. And they need to challenge the comforting, but likely false belief that insurance provides adequate coverage.

Delaying the transition to net zero is no longer a cost-saving strategy. Reframing the corporate definition of “business success” to include longevity and resilience is required to reset thinking and wake companies up to the rapidly changing impacts of climate change given the acceleration in global temperatures.

How CEN can help

A refined and thorough process based on detailed physical risk assessment methodologies, is core to CEN’s climate risk assessment offer. We provide clear guidelines and work closely and collaboratively with sustainability and finance teams to help them assess and quantify climate risks within their regulatory and business contexts. Contact us for more information.