Weather Insurance: What It Is, How It Works, Example
Weather insurance is a type of financial insurance that protects against losses or damages caused by adverse, measurable weather conditions. Wind, snow, rain/thunderstorms, fog, and unfavorable temperatures are common situations.
Weather insurance is frequently utilized as a standalone policy to protect businesses and their associated activities. As a result, these policies serve a variety of reasons, including covering an expensive event that could be wrecked by inclement weather. Insurers will cover businesses if weather circumstances result in a loss of revenue from events.
How Weather Insurance Works
Weather influences our daily life and has a significant impact on corporate revenues and earnings. So, weather insurance, purchased as a standalone insurance policy, is widely used to safeguard businesses and their connected activities—for example, insuring an expensive event that could be ruined or badly disrupted by bad weather. Vortex Insurance Agency, "Understanding Weather Insurance." Accessed: June 16, 2021. Weather insurance can cover a variety of events, including festivals, concerts, trade exhibitions, seasonal events, parades, film shoots, fundraisers, and athletic events. Individuals can also utilize it to cover large events, such as an outdoor wedding.
Conventional weather insurance generally covers low-probability meteorological phenomena such as hurricanes, earthquakes, and tornadoes. Insurers would provide payment if weather circumstances resulted in a loss of revenue from events or the cancellation of them entirely.
The premium for weather insurance is determined by a variety of factors, including location and time of year. In other words, the monetary amount clients pay for coverage is calculated by the likelihood of the insured weather event occurring and the potential loss. An actuary at the insurance business examines meteorological data dating back decades to determine how to price a policy. If, for example, Cleveland experiences a white Christmas every ten years, the insurer understands that the likelihood of such an event is 10% and will set insurance prices appropriately.
Purpose of Weather Insurance
Weather insurance is a requirement for many businesses and is seen as an important risk management approach. It's also very configurable. For example, an insured party can specify the number of days, weather events, and intensity of weather covered by the policy.
Businesses sometimes utilize these regulations as a sales gimmick to entice customers. For example, a furniture business may advertise that all furniture purchases made in December will be free if it snows more than two inches on Christmas. In such circumstances, the store will purchase insurance to cover the unique event.
Example of weather insurance.
Assume an event planner is organizing an outdoor festival for a weekend in the summer. Although they sell festival tickets, the event organizer also hopes to make money from sales of food, drinks, and products—a portion of what the many vendors are offering. The organizer determines the date but is doubtful whether the weather will cooperate.
To ensure that the festival runs smoothly, the organizer chooses to get weather insurance. If the festival receives a low turnout owing to weather, the organizer may file an insurance claim with the insurance provider to recover lost revenue, providing premiums are paid.
Weather Insurance vs. Weather Derivatives
Until recently, insurance was the primary tool used by businesses to protect against unforeseen weather conditions. The problem is that traditional insurance typically only covers catastrophic loss and does not protect against diminished demand caused by warmer or colder than expected weather.
Enter weather derivatives. They offer some protection, but they are not insurance. Instead, they are financial products used by businesses or individuals to hedge against the risk of weather-related losses. The seller of a weather derivative promises to bear the risk of disaster in exchange for a premium. That means that if no damages occur before the contract expires, they will profit. In the event of unexpected or unfavorable weather, they compensate the derivative buyer for the agreed-upon sum.
Weather Derivatives Background
In the late 1990s, people realized that if they measured and indexed weather in terms of monthly or seasonal average temperatures and assigned a dollar price to each index value, they could "package" and trade the weather. Aquila Energy completed the first such transaction in 1997 as part of a power contract.
From this, the weather became a marketable commodity, similar to trading the fluctuation of stock indices, currencies, interest rates, and agricultural commodities.
Weather derivatives typically address low-risk, high-probability events. Weather insurance, on the other hand, usually protects against high-risk, low-probability events as outlined in a highly personalized policy. Because weather insurance and derivatives address two distinct possibilities, a corporation may be interested in purchasing both.