Precisely quantifying climate risk is essential to comply with evolving climate reporting requirements. More importantly, it is critical to making informed decisions about building resilience in a warming world that’s shifting to a lower-carbon economy.
However, many organizations will face obstacles in securing robust insights to help them manage climate risk effectively. There are perhaps three challenges that cannot be overlooked.
See also: Climate and Catastrophe Risk Strategies
Challenge one: Carbon emissions do not provide the full picture
While quantifying carbon emissions is important in terms of meeting certain disclosure requirements, this will not provide a comprehensive view of climate risk.
A 2023 joint report from WTW and the Institute of International Finance highlights how emissions quantification tends to be backward-looking and therefore may not capture how the profitability of a business is likely to be affected into the future. There’s also a low correlation between financial risk and carbon intensity.
This means an organization needs to find additional techniques to quantify climate risk. These methods should be capable of measuring the consequences of physical climate change on a company’s assets and the secondary effects resulting from changes in business models and supply chains as they adapt to a lower-carbon economy.
As the transition to net-zero leads to policy, legal and market changes, some organizations could face significant moves in asset values, cashflows and higher costs of doing business. Analytical techniques can let you quantify transition risk as a financial impact.
Using this type of approach, you can define transition risk as the difference in future value between a business-as-usual scenario and a given number of transition scenarios. You can then feed these outputs into your transition plan disclosures and, more crucially, into strategic decision-making more likely to support resilience and growth.
Challenge two: Quantifying climate risk beyond tick-box disclosure
Quantifying climate risk takes time and effort. In terms of efficiency, it’s better if your climate reporting outputs are useful for more than simply ticking climate-reporting boxes. Ideally, you need information that not only guides your ability to meet climate and sustainability commitments but also ensures capital is allocated in the right places to protect against climate-driven uncertainty and volatility.
Once you use techniques that let you measure the financial impact of your specific physical and transition risks, you can better justify the need for proactive measures and achieve a stronger return on investment.
Analytical modeling can also enable you to explore multiple scenarios, pressure test your assumptions around strategic decisions, anticipate and respond to changing risks and adapt your strategies accordingly. When robust climate analytics is embedded in your organization, you can improve your risk transfer and adaptation strategy to reduce your physical risks and make business decisions more likely to outperform your peers in the transition.
This risk quantification approach can support your climate reporting requirements while generating the insight you need to inform resilience against physical or transition-risk related events or losses.
See also: How AI Can Help Insurers on Climate
Challenge three: Qualitative methods lack precision
Climate risks are complex and intertwined. It’s understandable why your organization may turn to more traditional qualitative methods, such as scenario analysis workshops, to provide a high-level understanding of potential future outcomes.
However, these processes are resource-intensive and rely on being able to get business leaders together regularly to build consensus on identifying and quantifying the risks the business needs to prioritize. The process may also lack precision and repeatability.
Dynamic physical and transition risk models and algorithms provide a more objective, repeatable and auditable approach. These models allow you to create a perspective you can track through time, verifying the assumptions and causality behind the insight you generate.
These perspectives can complement climate risk governance forums like senior stakeholder workshops or risk committees, enabling the business to validate and test climate risk management strategies.
With robust, repeatable and transparent climate risk quantification, it’s easier to demonstrate to auditors or compliance officers how the business arrived at key decisions and be confident you’re allocating resources in optimal ways to support resilience and growth in the face of complex climate risks.
Dynamic climate risk quantification models can also give decision-makers real-time feedback on the financial impacts of complex changes resulting from climate risks. This feedback helps prioritize actions and focus on acute problems that could challenge the viability of operations in the future.
By having tools you can engage with frequently over a year, or even over a decade, you can explore the changing landscape as part of a continuous process, generating auditable feedback on what's driving your progress to reaching a climate-resilient future.
