By MATTHEW BRODSKY, senior editor/Web editor of Risk & Insurance®
MIAMI---Weather risk management is a pretty self-sufficient niche in the insurance world, with its bespoke risk-transfer deals and index-based derivatives markets. Yet despite the equilibrium, members of this marketplace have a familiar refrain about the need, and the search, for growth.
It makes sense considering recent trends. The total notional value of weather risk contracts between April 2008 and March 2009 was about $15 billion, down from $32 billion the previous year--a drop of nearly 53 percent. Once upon a time, during the 2005-2006 period, the value had reached $45.244 billion. (No figures have been released for the 2009-2010 period.)
One method of expansion has been geographical.
"The concept of using weather risk management tools is being accepted by more and more organizations around the world," said Sandeep Ramachandran, director of property and specialty at Swiss Re, a major player in weather.
Perhaps India is the best example of this global growth. The market for weather insurance for agriculture went from $22 million in 2008-2009 to $100 million in 2009-2010. The Weather Risk Management Association (WRMA), the global group representing the weather niche, estimates that the weather risk market could reach $7 billion to $20 billion in five years. India's renewable energy and aviation sectors could also tap the weather market.
Mature weather markets exist in Western Europe, Australia and Japan and weather risk management is growing in Latin America too. One of the most sophisticated deals of last year was done in Chile, involving an energy company and a contract based on precipitation and crude oil prices, according to Wilson Huynh, senior vice president with MMC Securities, who spoke at the WRMA annual meeting in Miami from May 10-12
Another way for the weather risk world to broaden itself could be to partner in some form or another with another galaxy in the insurance universe dedicated to weather-related risk, the insurance-linked securities market. ILS amounts to about $23 billion annual, according to Trading Risk magazine, and includes catastrophe bonds, collateralized reinsurance and industry-loss warranties. While the connection between "pure" weather plays and ILS instruments makes obvious sense to the layman--both transfer the risk of Mother Nature behaving "badly"--the connection to market participants is starting to become more apparent.
One only need to speak with WRMA board member Ramachandran, who is familiar with the work of his colleague Mariagiovanna "Patti" Guatteri, a director at Swiss Re Capital Markets, and vice versa. They agree that the tasks of weather risk and ILS professionals do have their similarities.
Take the weather derivatives markets at the CME Group and the hurricane futures market there too.
For end-users--say the corporate risk manager at a multinational energy company--weather and ILS products could create a spectrum of risk transfer, with weather handling everyday-type fluctuations in precipitation and temperature, ILS protecting against the megadisasters at the wee end of the tail.
Still, for all that weather is in the news--hello, climate change?--growth is not a given.
One reason is that weather risk tools are predominantly still used by one sector, energy, as reported by Huynh.
That's despite a push by the industry to attract other sectors. One reason could be that energy end-users are sophisticated and perhaps more comfortable with the complexities of weather risk. Their risk-transfer deals tend to be set up to better minimize basis risk.
And basis risk scares many end-users. They don't like the uncertainty that they could purchase a weather hedge, suffer a loss and yet not have the hedge triggered.
Take the North American agricultural business. Weather folks have talked about expanding here for years but success has been limited. One, because U.S. and Canadian crop insurance is subsidized.
Another issue is that many farmers have the belief that if an event hasn't happened to them yet, it'll never happen to them, said Fred Simons III, a crop insurance agent at Carden & Associates Inc. in Lakeland, Fla.
"That's a fairly large barrier, or hurdle, to get over," he said, adding that he gets a lot of calls from growers for insurance only after they lose a crop.
Yet government-subsidized crop insurance isn't available for all crops or locations--such as Florida strawberries--and some larger growers also sometimes say, "I don't want to deal with the government at all," explained Simons.
Opportunities for weather risk transfer could also exist with end-users downstream like agricultural processors and aggregators, said Joe Brandonisio, vice president and account executive at Aon Benfield.
Expect the weather risk management sector to pursue these and other paths toward growth. The slogan for the 2010 WRMA meeting, after all, was, "Broadening our reach." Yet the market will continue to need to educate the end-user market that weather risk can be effectively transferred, and will need to overcome the image of its products as expensive, complex and optional.
May 13, 2010
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