The insurance industry doesn’t really like bad weather. The storms of 1987 cost Lloyd’s of London something in the region of $2bn, and with El Nino having wreaked havoc in the US and southeast Asia over the last year, insurers are probably pleased that the phenomenon only comes around every seven years or so.
But Lloyd’s underwriter Brockbank Syndicate Management has decided to turn the equation on its head. Rather than just offering cover for severe weather-related business interruption and storm damage on commercial property, it has recently launched weather stabilisation insurance (WSI) – cover against mild weather conditions.
The obvious candidates for this insurance are the energy firms: “If the winter is milder than normal, we’re not going to use as much gas to heat our houses,” explains Mahmud Bhatti, senior class underwriter for energy and liability at the firm. Or an ice cream maker might lose sales to a cool summer. “We’re looking to protect the bottom line of these companies,” he says.
Of course, many businesses use uncertain or unusual weather conditions to excuse poor sales performance. Indeed, when Financial Director looked at all the company reports on the Regulatory News Service over the last few months, most of them contained a mention of the way in which the poor weather earlier in the year had hit revenues.
Some of these firms actually published a revenue figure adjusted for the weather. Viridian Group, formerly Northern Ireland Electricity, weather corrects both demand and sales figures, but although this may give a more accurate picture to shareholders of real trends in the business, the revenue is still lost.
Bhatti clearly feels that this recognition of the effect of mild weather justifies the decision to offer WSI. “There’s such a vast range of industries that are exposed to weather patterns that are milder than normal,” he says. “The companies who are going to buy this cover are those which are looking to smooth their income.”
WSI uses regional temperatures recorded by independent agencies (the Met Office, in the case of the UK) as the guide for both premiums and payouts. The key indicator is ‘degree-days’, which are calculated from the average highs and lows each day and by how much they vary from the norm. A company seeking cover would consult the underwriter and choose a level of cover, usually based on their own losses attributed to historical deviations in the degree-day figure. Thus, while companies are unlikely to recover all their potential losses, they can recover a fixed amount dependent on the extent of the variance.
Companies which are highly sensitive to fluctuations could choose a higher premium which has a narrower band of degree-day variance within the ‘acceptable’ level. Firms which only require a payout if there has been a sizeable change in prevailing weather conditions would select a wider, but cheaper, band.
Bhatti is keen to emphasise the openness of the cover. “One of the beauties of WSI is that it’s very transparent. When we work out a premium, you’ll know what we put into the calculations – what we’re charging and why we’re charging it.” And there’s no loss assessment: the payout is entirely derived from the independently audited degree-day variance.
Brockbank is particularly enthusiastic about WSI because, as well as being usable by almost any company, it could be the start of a whole raft of new financial products. “The basic concept can be applied to any weather, whether it’s rain or snow or whatever,” Bhatti points out; it just depends on having a predictable norm and calculating the potential effect on business.
“If we could create a weather index people could trade off that and create positions,” he continues – and unlike the equity futures indices, there can be no question of trying to ramp the market. Only God can do that.