Weather Risk Management - Overview

Overview

Energy, agriculture, transportation, construction, municipalities, school districts, travel, food processors, retail sales and real estate are all examples of industries whose operations and profits can be significantly affected by the weather. For example, unusually mild winters diminish consumer demand for heating and erode the profit margins for utility companies. Unexpected weather events can cause significant financial losses. Weather information and forecasts utilized in risk management decision making is often referred to as meteorological intelligence.

The weather risk market makes it possible to manage the financial impact of weather through risk transfer instruments based on a defined weather element, such as temperature, rain, snow, wind, etc. Weather risk management is a way for organizations to limit their financial exposure to disruptive weather events. By making a payment (a "premium") to a separate company that will assume the financial weather risk for them, an organization essentially is buying a type of insurance - the company assuming the risk will pay the buyer a pre-set amount of money which will correspond to the loss or cost increase caused by the disruptive weather.

Catastrophic weather events such as hurricanes are typically managed through traditional insurance contracts that pay based on indemnity loss. Insurance is a heavily regulated industry with specific requirements and qualification criteria. Due to the indemnity nature of insurance, actual loss must be proven to an insurance carrier before the payment can be processed. In contrast, financial loss such as erosion of margin, portfolio loss or increased expenses usually do not qualify for insurance payouts. Financial instruments such as derivative transactions can provide more flexible and customized risk management opportunities than the typical insurance contracts as they are priced and settled on the parameters of measured weather rather than the associated financial loss.