Weather Derivatives Backed By Climate Change Clamor

According to William W. Windle, managing director of Munich Re Trading LLC, business has been brisk lately in the weather derivatives market.

There are many reasons for this, and while Windle may wince at any suggestion that the current weather and the climate are necessarily tied together, he has no problem giving the topic of climate change some of the credit.

“With the discussion of climate – rightly or wrongly – more people pay attention to the weather,” Windle said.

Weather derivatives aren’t considered an insurance product, but more insurers and reinsurers are getting into the weather derivatives game, according to Steve Evans, owner of Artemis, a U.K.-based website that covers alternative risk transfer, catastrophe bonds and insurance-linked securities and investments.

Evans launched Artemis in 1999, and as a long-time market expert he has watched the market change from the time of the Enron collapse to energy regulation to its current evolutionary phase. In the last few years, he’s seen growing interest from insurers and reinsurers, and he thinks that interest is going to continue to build thanks to changing appetites, investors seeking ever-diverse opportunities and talk of climate change.

“I think it’s something that should pick up,” said Evans, whose site reports an average of 30,000 readers per month. “I think it makes sense as a product, since every business is exposed to the weather. I think the real opportunity, and where we’ll see the market growth, is how big companies can bundle weather components in insurance policies for large corporations. I think a lot of insurance and reinsurance companies would like to be offering complex solutions combining weather products.”

Evans and other experts credit climate change, or more precisely all the publicity climate change gets, with helping to make people more aware of the weather, and helping drive interest in weather derivatives and weather-related financial products.

In addition to greater awareness, the tools to forecast weather and its potential impact are becoming more sophisticated, so the need to hedge those losses becomes more apparent, Evans said.

Munich Re paved its way as a leader in weather derivatives with its acquisition of RenaissanceRe Holdings Ltd.’s unit, RenRe Energy Advisors Ltd., in 2013. Munich Re Trading’s primary line of business is to provide weather risk management products to corporate customers on a global basis.

Those customers come primarily from the energy sector, which buys products to protect them from underselling electricity on cooler-than-average summers, or selling less gas during mild winters.

“These companies have a real financial exposure to different types of weather,” Windle said.

The brunt of their weather products are in derivative form and offer mitigation against temperatures, precipitation, exposures to normal winds, lack of sunshine.

The two latter exposures are where Windle and others in the weather derivatives game have gotten a lot of business from lately.

Renewable energy concerns like wind farms and solar farms are big buyers of these products.

Weather derivatives and weather products providers are getting more renewable customers with the proliferation of wind farms in Europe and the U.S., where mandates are in place requiring energy companies to purchase a certain portion of their energy portfolio from renewable energy providers.

Martin R. Malinow, president of Endurance Global Weather, said he’s seen a lot of business from the renewable energy sector, often from new installations with bank loans that require the purchase of weather products.

Bermuda-based Endurance sells products like WeatherLock, WindLock, TempLock and RainLock.

Wind farms that need a loan to build, for example, are often required to purchase products that trigger a payout when they don’t get enough wind.

“Typically now we’re seeing banks push developers to obtain risk management products like wind protection,” Malinow said.

Windle, on the other hand, says most of his renewable business comes from traditional energy companies exposed to the growing renewable business in another way.

If the wind blows a great deal one year in a certain area, then output from a local traditional energy facility may not be needed as much because it has been replaced with wind-generated power. To hedge against this drop in demand, a traditional energy provider will buy a wind product from Endurance that is payable based on a trigger point at which the wind blows too much.

“Companies that own little or no renewables actually have quite an exposure to the renewable space,” Windle said. “We’ve seen more requests from that side of the market.”

Max Messervy, manager for the insurance program for Ceres, a nonprofit leadership sustainably advocate, said there is no doubt that interest in the market is being driven by concern over the impacts of climate change.

“It’s really fascinating how rapidly this market has grown in the last couple of years,” Messervy said.

Messervy acknowledged that some of the growth he’s seen is also due to growing demand for alternative risk products, but he said climate change awareness is also a part of that demand.

“There’s kind of this sense (from companies) that with the growing number of catastrophes, that maybe we can diversify risk beyond the insurance model,” Messervy said.

Malinow is less sold. He believes the uptick in businesses isn’t so much due to climate change or the clamorous climate change conversation, but that more companies want to diversify their risk and there’s nothing more behind that.

He credits storms like the ones that blanketed the Northeast in snow this winter, as well as the ongoing drought in the West, as the real marketing force behind weather derivatives.

“I would say, at the end of the day, weather is better a marketer, climate’s not,” Malinow said.

Tom Johansmeyer, associate vice president of reinsurance services and marketing at ISO/Verisk Insurance Solutions, is also dubious about the hand that climate change has had in market growth.

ISO/Verisk deals in cat bonds, collateralized reinsurance and industry loss warranty contracts, among other things.

“Obviously the insurance-linked securities space is growing,” Johansmeyer said.

The true driving force behind the market’s growth is those who have been working to shop these products around to both buyers and investors, he said.

“The strategic value of these tools are getting recognized,” Johansmeyer said. “Obviously there’s a lot of capital out there that wants to get into this market.”

Johansmeyer said the yields and the fact these products aren’t tied to the stock markets make them attractive to investors, such as large pension funds that must diversify their investments.

In fact, one could say there’s too much interest.

“There is more potential capital than there is opportunity to deploy it,” Johansmeyer said.

Past columns:

Earth Day, Climate Change and Drought

How Another Country’s Insurance Industry Is Facing Climate Change

U.S. Dominates Climate Change Litigation

Climate Change Modeling on Cusp of Paradigm Shift

Climate Change Regulations for Insurers Not Out of Realm of Possibility