Investors are reorienting their focus from transition risk to physical risk as the climate shift momentum stutters, according to the "Investing in a changing world" report published by CPP Investments Institute and OMFIF.
The cost of damages from wildfires, floods, and storms have increased; losses from such disasters exceeded US$400 billion in 2024. Greece's wildfire season was at its most intense; extreme heat in South Asia resulted in power outages, crop failures, and widespread health issues.
The goal of reducing warming to 1.5°C (2.7°F), supported by the Paris Agreement and progressve commitments from countries and corporations, initially indicated that the financial effect of transition risk would be observed sooner and would be more significant than physical risk. However, the ascension of leaders with regressive climate agendas in major economies has resulted in policies that could see warming rise to 3.1°C (5.58°F) by the end of the century, according to the United Nations' most recent Emissions Gap Report.
Insurance markets are increasing premiums, constricting terms, and even rescinding coverage in certain cases. Assets that cannot adapt adequately have become difficult to insure. The report also noted the potential for unmitigated physical risk at the asset level to become a systemic risk because it can affect critical infrastructure and value chains.
The report suggested that forward pricing for insurance, if made readily available, could aid in quantifying physical risk and the pros of resilience investment.
"Unlike other sustainability factors that have proven harder to quantify, physical risk and its mitigation will translate directly into security prices through insurance costs or the direct impairment of asset values," said Richard Manley, CPP Investments' chief sustainability officer, in a statement.
Funds have integrated current advanced climate risk analytics, refined engagement strategies with investee organizations, and championed industry-spanning data collection and transparency enhancements. Presently, physical risk impact is being acknowledged across different asset classes, but it has proved challenging to integrate into investment decisions.
Nonetheless, investors who incorporate climate risk considerations into core investment frameworks are better prepared to handle a volatile future.
"At least in the sustainability space, it is reasonable to assume that most of the innovation in financial markets over the next decade will be in the underwriting and pricing of physical risk," Manley said.