Standing up to the weather

Channels: Investors, Markets

Companies: Swiss Re

Adverse weather forces companies to look for protection

The number of extreme weather events worldwide has increased more than fourfold since 1980, causing losses in the billions, of which only a fraction is insured. On the global average, 55% of windstorm losses and 86% of flood losses are not covered by insurance. The levels of protection differ widely between mature markets (Western Europe, North America, Japan) and developing markets (Latin America, emerging Asia), where up to 80 and in some areas even 100% of the economic losses still remain uninsured today.

Climate change will further aggravate the situation. Swiss Re identified climate change as an emerging risk more than 25 years ago and integrated it into its long-term risk management strategy and insurance offerings. Today, Swiss Re Corporate Solutions is among the market leaders in providing "weather protection" solutions and has pioneered various truly innovative transactions.

Extreme weather events can affect profitability of almost any industry

Climate change is not only leading to more frequent extreme weather events but is also prompting critical deviations in weather patterns. Apart from storms causing property damage, typical extreme weather events include prolonged periods of drought or heatwaves, while climatological deviations range from milder winters to summers with more rain and unusually calm periods with little or no wind.

Agriculture, construction, retail and the travel industry are the most obvious victims of such changing weather patterns. However, other sectors, such as the energy industry, are also negatively impacted.

The types of damage triggered by these events range from property damage to business interruption, fluctuations in demand and supply and price volatility on the commodity market. Even events on a smaller scale can drastically affect sales and create severe losses for an enterprise.

Weather derivative solutions can bring relief from whatever risk nature has in store

Worldwide, an abundance of data has been gathered on all aspects of weather over the years. This allows us to back-test and check the effectiveness of a given risk transfer solution against previous years to determine how this protection solution would have performed. Analyses of this kind allow companies to quantify potential losses and savings with ease. Conversely, weather data can also be used to identify opportunities where a certain change in weather patterns may effectively boost sales or productivity.

Examples of weather risk protection

Energy. Weather risks have risen to the top of the agenda of many executives in the energy sector. The World Energy Council study Financing resilient energy infrastructure emphasizes the need to implement innovative risk management solutions for extreme weather and price risks. The main weather risk in the energy sector is the impact of air temperatures on retail energy demand. This demand uncertainty puts a serious strain on supply management and procurement, and this in turn has a significant impact on price hedging and margins. The tools to address weather risks in the energy sector include contract flexibility, storage and financial solutions such as weather derivatives. Utilities worldwide can insure themselves against the risk of poor energy sales in warm winters when customers spend less on heating. By the same token, they can compensate for an unplanned and expensive spike in energy demand for air-conditioning, when a summer is hotter than usual.

In the renewable energy sector, wind power producers have started to buy weather protection products to manage wind volatility. These products provide compensation for days with little or no wind, when wind turbines stand still and generate no power.

Agriculture. Farmers around the world can protect their income with insurance covers that link crop production to weather-related data from weather stations or satellite images. For example, a sugar beet grower in Russia automatically receives compensation if a severe period of frost lasts longer than what is agreed to be normal in his region. Meanwhile, a pineapple grower in Indonesia will be indemnified if satellite images confirm that precipitation was below the agreed usual levels during the critical pineapple growing phase.

Crop producers are not the only party along the agricultural supply chain who are able to benefit from weather protection products. Input providers, crushers, silo storage facility managers, financiers and millers can all protect themselves against unfavourable weather conditions and thus guarantee income linked to a minimum throughput. Weather protection can also be implemented in conjunction with commodity price volatility to guarantee revenues for crop producers.

Further applications of weather-index products go far beyond energy and agriculture sectors. For example, brewers in the UK can buy risk cover against cold wet summers which would hurt sales in their pubs. In France, construction companies can purchase insurance against days with too much wind, when workers cannot use overhead cranes on construction sites.

Despite growing awareness of the possibilities of weather protection, many companies still fail to manage their weather risks properly. We see it as our task to continue explaining the extent of global weather-related exposure and the vast opportunities available beyond traditional insurance offerings. What may have been considered uninsurable risks can indeed be protected effectively with a combination of creativity and solid risk management expertise.

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