Business risk is a function of the following formula:
Risk = Hazard x Consequence x Probability
When it comes to business climate risk assessments this formula is more complicated than it looks due to the multiple hazards in play, and the many potential combinations of consequences and probabilities. To better understand this business risk formula:
* Hazards are the underlying causes of potentially negative business outcomes. When it comes to climate change, there are a range of potential hazards that may or may not be relevant to a specific company:
- Physical hazards, e.g. the direct impacts of climate change on company operations, supply chains, and financial performance;
- Brand hazards, e.g. changes in consumer and investor perceptions and priorities;
- Policy hazards, e.g. laws, regulations, standards or other mandates;
- Structural hazards, e.g. changes in a company’s business environment due to the second-order effects of other hazards; and
- Liability hazards, e.g. potential legal responsibility for contributing to climate change, a potential business hazard being actively litigated today.
* Consequences encompass the potential manifestations of the various hazards at the company level, recognizing that each hazard is likely characterized by a distribution of potential consequences.
* Probability is the likelihood of a particular combination of hazard and consequence.
Risk gets complicated quickly as hazards and consequences interact. The likelihood of policy hazards, for example, almost certainly increases as physical hazards manifest themselves (hence Climate Action Tipping Points). Few business decision-makers have assessed their climate risks (or opportunities) in this way, often relying instead on pre-conceived notions of potential risk. Most common is the failure to pursue scenarios as part of the risk or opportunity assessment process.