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Weather derivatives (drught risk transfer)

by Piotr Matczak, Darryn McEvoy, Ilona Banaszak, Adam Chorynski

[other options]

What:
Higher levels of disaster risk can be managed using instruments provided by international capital markets such as weather derivatives. Weather derivatives are financial mechanisms that can be used by individuals and businesses as part of an overall risk management strategy. They are based on a specific 'weather' trigger rather than proof of loss, for instance temperature over a specified period, and therefore are simpler (and cheaper) to administer than other alternative options. Although applicable to most businesses, the greatest potential may be for use by the agricultural sector.
Extreme event: Drought; Floods; Heat waves; Sea surge
Type of option: Insurance and financial incentives
Risk management: Risk transfer
Sector: Insurance and financial services
Landscape type: Geographically non-specific
Location: Australia; Austria; Belgium; Bulgaria; China; Cyprus; Czech Republic; Denmark; Estonia; Finland; France; Germany; Greece; Hungary; Ireland; Italy; Latvia; Lithuania; Luxembourg; Malta; Poland; Portugal; Romania; Slovakia; Slovenia; Spain; Sweden; The Netherlands; United Kingdom; United States; other
Why:
Drivers of change: Socio-economic: many businesses are looking to the financial markets to help spread (hedge) their risk. There is particular interest from the EU agricultural sector which currently has limited access to multi-peril crop insurance.



Policy: Driven primarily by the private sector.
How and who:
Implementation: The scale is dependent on the entity taking out the insurance package, though will typically be at the individual or company level.
Institutional context: Weather derivatives are being developed as an Alternative Risk Transfer mechanism by the financial / insurance markets, so are mainly within the realm of the private sector. However the insurance industry is now working closely with policy-makers to assess the feasibility of a form of this type of insurance cover for farming activity.
Potential barriers: 1) Potentially high start up costs.
2) Accurate prediction of information is required.
Implications for sustainable development:
Implications for sustainable development: No direct benefits though may be indirect consequences.
Provides a safety net for businesses and livelihoods during periods of extreme weather.
Weather derivatives are considered valuable instruments for transferring more difficult risk to larger capital markets. On the investor's side, they receive a premium for allowing access to capital; buyers of the product receive financial recompense should an extreme event occur.
Resources:
Learning
and
knowledge transfer:
http://www.abi.org.uk/
The ABI (Association of British Insurers) is an umbrella organisation representing the collective interests of the UK?s insurance industry. The Association speaks out on issues of common interest - climate change is increasingly important to their business.
http://www.cea.eu/index.php?page=climate-change
CEA is the voice of the European insurance industry at European and international level and is active on a range of issues. Climate change is considered a key issue.
http://www.munichre.com/en/ts/geo_risks/climate_change_and_i
nsurance/default.aspx
Major re-insurance company.
http://www.swissre.com/pws/about%20us/knowledge_expertise/to
p%20topics/climate%20change/climate%20change.html
Major re-insurance company.
Evaluation: Costs will be location specific and will be determined by risk calculations.
Scientific references:
Miller, S., K. Keipi (2005). Strategies and financial instruments for disaster risk management in Latin America and the Caribbean. Inter-American Development Bank Washington, D.C. Sustainable Development Department Technical Papers Series.
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    • © 2009 ADAM, Adaptation and Mitigation Strategies: Supporting European climate policy