Whenever there is a snowstorm, planes are stuck on the ground, whenever it rains, outdoor swimming pools stay empty. 80 percent of all economic activity depends on the weather.
Karsten Berlage from Allianz Risk Transfer (ART) explains how businesses can protect themselves against mother nature’s mood swings.
Is there anything that is not blamed on the weather? Even levels of political satisfaction, which, as sociologists at the Freie Universität Berlin found out a few years ago, are significantly higher on sunny days. Maybe that’s why the record summer of 2015 will stay in the politicians’ memory for a long time. While they cannot help being at the mercy of the next meteorological gloom, the economy has found its own way of protecting itself against the mood swings of the weather.
Various types of weather insurance make this possible. “All over the world, a growing number of firms transfer the weather risk onto the market,” says Karsten Berlage, weather insurance expert at Allianz Risk Transfer in New York. A calculation made by the World Meteorological Organization a few years ago demonstrated how enormous the potential demand for something like this is, since 80 percent of the economy is contingent on the weather. According to The Weather Business study carried out by the industrial insurer Allianz Global Corporate & Specialty (AGCS) in 2013, between 1980 and 1989 damage worth USD 15 billion was caused by weather-related disasters. Between 2010 and 2013 insurers already had to chip in with 70 billion a year.
Climate change is making its presence felt. But the weather insurance Berlage is talking about doesn’t deal with hurricanes and other severe consequences of global warming. “When we talk about weather, we mean the routine fluctuations in temperature, rainfall and wind force. We insure against everyday weather risks.” This includes, for example, warm periods in winter that make hopes of profit for ski lift operators vanish into thin air. Or rainy summers that make owners of theme parks, beer gardens and summer clothes manufacturers look like fools.
A slight breeze
But there are also less obvious fluctuations that are of equal consequence. A slight breeze does not harbor any catastrophe potential as far as innocent bystanders are concerned. A wind turbine operator, on the other hand, requires a wind speed of at least four meters per second for his turbines to not stand still. The evidence against rogue weather conditions is overwhelming. According to an AGCS study, these cost the US economy alone USD 534 billion in 2012, or 3.4 percent of the country’s GDP. As for Europe, Allianz is estimating losses of around EUR 400 billion. To compare: damage caused by natural catastrophes all around the world amounted to USD 170 billion in 2012.
But businesses can no longer use the weather as an excuse for fluctuations in revenue. Since investors and consumers expect businesses to come up with solutions even in difficult times, the insurance industry began developing weather insurance products back at the end of 1990s. For example, when a company’s, say an airline’s, credit rating is being evaluated, it is now also taken into consideration whether that company is insured against weather risks. After all, every year 70 percent of all the delays in the US air traffic are caused by the capriciousness of the weather.
Berlage’s team has been busy developing weather derivatives since 2008. The biggest difference between these derivatives and conventional insurance is that they do not need physical loss or damage as prerequisites. Indemnity payments can be triggered by clearly defined deviations from the agreed indicated value, be that a maximum or a minimum value, or an average. A measurement range is also possible.
The risk coverage spectrum comprising various types of weather insurance and weather derivatives is constantly growing. “At the beginning we were careful about putting out feelers, but since then we’ve plucked up the courage and are currently offering a whole plethora of products – provided, of course, that the customers fulfill the requirements.”
These high spirits described by Berlage also have something to do with progress made in the area of meteorological data capture. Weather records can also benefit from the rapid digitalization. The super computer in the head office of the German Meteorological Service processes up to 20 million pieces of data every day. Across the world, computers feed countless measuring stations on land, sea and in the air.
Not off the rack
In places like Africa, where weather observation is still in the early stages of development, satellites are a great help.
“But there is no way we can place all the data within a historical context,” Berlage points out. Yet the historical stream of data is fundamental when it comes to working out insurance premiums. “Let’s assume that a measuring station in Munich-Riem has been recording the amount of rainfall and temperature for the last 100 years. If you were now to measure the same parameters 20 kilometers away, it might still work for the temperature. But the two locations are actually too far apart to protect against the risk of rain. That’s what we call basic risk, and it comes at a price.” This example demonstrates that there is no such thing as ready-made weather insurance. “Each situationis structured in a different way,” says the Allianz manager.
Anyone who has anything to do with the weather is familiar with incalculability. Diversification is the most effective tool to counteract it. For deviations at times of climate change to remain eligible for insurance, risks must be diversified. That’s the reason why the weather insurance clients are distributed all over the world.
The geographical variables are joined by their temporal counterpart. In this respect, Berlage prefers contracts that distribute the risk over the entire year, for example in the field of alternative energy. Power plant operators don’t care whether it’s windy or sunny. Unlike an ice-cream stall, the plant does not need to make all its profit within a few weeks. “Ultimately, it would be perfect if a wind turbine operator wanted to insure himself against both types of risk, a slow season and overflow, at the same time.”
With that statement Berlage rounds off his musings on the subject of diversification.
Weather insurance is aimed at customers who are afraid that weather fluctuations will have drastic consequences. In other words: it guarantees their existence. As a general rule, costs vary depending on the occurrence probability. For instance, if a beer garden owner wants to insure himself against a shortfall in sales from the 11th rainy day onwards, he would have to pay more than if his insurance policy were to come into effect on the 16th rainy day.
In other cases the issue is not business but the welfare of a whole country. Around 75 percent of Brazil’s energy
needs are covered by hydroelectric power. Right now, the gauge of 44 of the total of 45 water reservoirs is below its historical average as a result of a major drought, and if that is the case, the whole economy is under threat.
All hail the government that has made provisions for such extreme cases. Although weather insurance cannot put a stop to a drought, it can indemnify companies that, for example, have suffered a power cut.
Author: Michael Grimm.
This article was originally published in the 'Allianz Journal' (03/2015).