Weather Insurance
The Economist magazine this week has an article on hedging against the weather and against catastrophic events: Natural hedge: Interest grows in financial instruments to offset swings in the weather, The Economist, 2005-09-29. (Subscription may be required).
Two types of contracts are described:
- Weather derivatives, used by companies to counteract the financial effects of temperatures, windspeeds, rainfall, etc on their business operations. These derivatives are now traded on exchanges, such as the Chicago Mercantile Exchange, and over-the-counter. In addition, derivatives traders are willing to consider one-off contracts, so-called “exotic contracts”, for particular situations.
- Catastrophe bonds, or cat bonds, used as insurance against catastrophes, such as hurricanes and earthquakes. These act like insurance, with risks being pooled across different catastrophes.
Most large carbon emitters whose business is affected by the weather, such as energy companies, probably already include weather derivatives in their hedging portfolio. In the new environment of mandatory carbon emission rights, the argument for using these intruments is even stronger, since the financial effects of inclement weather and catastrophes may be greater for many companies.
The Economist article mentions Speedwell Weather Derivatives, a London company offering software and consultancy on weather-based financial instruments.