The Weather Business How companies can protect against increasing weather volatility
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Allianz Global Corporate & Specialty The Weather Business How companies can protect against increasing weather volatility
Allianz Global Corporate and Specialty
Foreword
Deviations from expected the globe. Further growth is anticipated as such solutions
weather can challenge any continue to gain relevance, particularly in areas such as
company’s revenues, costs alternative energy, agriculture and retail.
or profits. The weather risk
management market enables Yet, despite this growing awareness many business
businesses to actively manage professionals still have a lack of understanding of the
such financial risks based on the weather risk management sector. The industry itself is
weather event or variability in partly to blame, with its jargon and technical terminology
question – be it temperature, rainfall, snow, wind or even sometimes obscuring the essential simplicity of its
a combination of such perils. solutions. As a result, the full potential of weather risk
management remains untapped with many businesses
Although still relatively young, the weather risk not grasping that there are also opportunities to be
management market has evolved beyond all recognition derived from changes to expected weather.
in the 20-plus years it has been in existence.
With weather volatility forecast to continue to increase,
From its origins in structuring heating degree day this report offers a practical guide to the role weather
(HDD) swaps in the energy sector, the weather risk management solutions can play in mitigating such
risk management market has now developed to a risks, as well as identifying the benefits they can bring.
point where, although not yet fully embraced by the We hope not only to support greater awareness of their
mainstream, its solutions are increasingly being used potential, but also to encourage dialogue and debate on
across a range of sectors and scenarios. the future development of such solutions.
Today, growing numbers of companies are turning to Karsten Berlage
this market in search of solutions for weather-related Global Head of Weather Risk Management
business risks. The market is responding in kind with Allianz Risk Transfer
increasingly innovative products in locations all around
2
The weather business
Contents
Executive Summary 4
Introduction 6
Weather volatility is increasing. Hurricanes and floods grab the headlines but
changes in the weather do not have to be as extreme to impact a company’s
profitability. For many businesses a small change away from expected weather
can mean a large change in income
Exploring the link between weather and business 9
Although the majority of businesses are exposed to weather risks, many are
The alternative energy sector is one still failing to adequately identify and manage the impact changes in climatic
of the many industries impacted by conditions can have on their own revenue streams
variances in the weather
Impact of weather variances on businesses 13
Sectors such as energy, retail, food, clothing, tourism, distribution, transport and
construction are just as sensitive to minor changes in the weather as they are to
movements in interest and foreign exchange rates in terms of the impact this can
have on profits
Protecting financial performance 17
Some businesses have clear exposures to certain weather perils; for others
evaluating weather risk may require deeper analysis of a combination of perils.
Various risk management coverages can be structured for an increasing number
of scenarios
The deal is in the data 26
Availability and access to weather data has improved dramatically over the past
decade, strengthening the argument for strategic weather risk management and
enabling protections to be structured even in remote locations around the globe
The weather forecast 30
Demand for weather risk management solutions will grow significantly in the
future with stakeholders able to reap the benefits of better cash flow stability,
more accurate budget management, greater earnings consistency and higher
Allianz Risk Transfer
Group (ART) is the risk-adjusted returns
center of competence
for alternative risk
Glossary 32
transfer business within
the Allianz Group. ART
Group companies are Sources 33
subsidiaries of Allianz
Global Corporate &
Specialty SE Contacts 34
3
EXECUTIVE
SUMMARY
Executive Summary
• Changes from the expected weather can challenge any
company’s revenues, costs or profits
• Economic fall-out from major events grabs the headlines but
minor weather variances can significantly impact business
• Companies cannot control the weather but they can mitigate its
financial impact
• Innovative weather risk management products enable businesses
to actively manage financial risks around the globe
• Demand for solutions to increase significantly in future, driven by
more volatile weather activity and growing awareness of benefits
Weather volatility is increasing significantly. Weather impacts all commercial activities
Insurers have the bills that show damages with 70% of companies exposed to
from weather-related natural catastrophes “severe weather risk”. For example, the
are rising rapidly. Between 1980 and 1989, cost of weather-related delays to trucking
$15bn a year was paid out for such events. companies in the US is as much as $3.5bn a
Between 2010 and 2013 alone this totaled year. Weather is the cause of approximately
$70bn a year1. 70% of the delays in the US National Airspace
System, costing at least $3bn2.
The weather does not have to be extreme
in order to have a negative impact on cash Estimates indicate over 30% of US gross
flows. Sometimes it is merely enough for domestic product (GDP) is directly or
it to be uncommon, unseasonal or even indirectly affected by weather and climate
unexpected. For many businesses small ($5.7trn of $15.7trn). Moreover, routine
changes in temperature, rainfall, sunshine, weather variance on the economy is a much
All $ US$ unless
otherwise stated snowfall and wind levels can mean a large as 3.4% of GDP or $534bn, based on 2012
change in income. figures3.
Volatility may be becoming more common Many industries are as, or even more,
around the globe but many businesses are sensitive to variance in weather patterns
still failing to adequately mitigate the risk than they are to interest rate or foreign
posed by changes in climatic conditions to exchange movements including energy,
their own revenue streams. retail, food, tourism, distribution, transport
and construction.
4
The weather business
However, deviations from expected weather is no excuse entice potential buyers of convertibles with a “sunshine
for businesses incurring volatile revenues, higher costs or guarantee”. This works by protecting the consumer
disappointing earnings – this is increasingly less accepted against a lack of sunny days when they are unable to
by stakeholders. While companies cannot expect to have the roof down.
control the weather they are now expected to better
control the risk of its financial impact. An increasing number of governments and corporates
will be expected to more actively manage weather risks
Weather risk management is the management of moving forward as the awareness of the significant
financial risks that are directly or indirectly linked to the impact these can have on their financial performance
occurrence of an observable weather event or variability continues to grow. Today, this is still underestimated.
in a measurable weather index. Crucially, no physical Weather will increasingly be viewed as a core risk to
damage is required for a payment to be made, unlike business performance.
with traditional insurance products.
Weather risk management tools will become an
Such products focus on the use of weather data – increasingly powerful weapon in the risk manager’s
30% measurable weather variables such as temperature,
precipitation, sunshine, snowfall and wind – as the basis
armory, helping to combat growing shareholder concern
about the impact even minor changes in weather
for risk indices. Protection is based around the accurate patterns can pose to returns.
recording of independent weather data.
Percentage of US GDP
impacted by the weather Demand for such tools will increase significantly in the
For example, energy companies – both in the traditional future with companies able to prove they have mitigated
and alternative sectors – are major buyers of weather risk certain risks and protected revenues, making themselves
management solutions. They prefer cold winters and hot more attractive to investors. The introduction of weather
summers and protect themselves against unfavorable risk management products in the utilities sector has
seasons to safeguard revenues. Meanwhile, wind farm directly resulted in higher market valuations.
$534bn operators seek protection against low wind levels to
protect their financing. The weather needs to be defined in such a way that it
describes a business risk or opportunity. A failure to do
Coverage is available for single and multiple weather so means that businesses are missing the opportunity
Impact of routine weather
variance on the US perils and is becoming increasingly innovative, moving for better cash flow stability, more accurate budget
economy into new areas ranging from protecting the crops of management, greater consistency of earnings and
farmers across Africa from drought to jewelry stores higher risk-adjusted returns.
from a drop in earnings in the event of customers being
unable to go shopping because of heavy rain or snow. In the future, those weather-sensitive companies who
INTRODUCTION
Weather variances can impact attendances at sports events and venues and result in cancellations
Introduction
Adverse weather patterns are increasing around the world. While natural catastrophe
events such as hurricanes and floods grab the headlines, weather activity does not have to
be as extreme as these to have a negative impact on a company’s profitability. For many
businesses a small deviation from normal weather patterns can mean a large change in
income. Such risks call for new solutions to manage them more effectively
The weather is changing. Volatility is increasing According to Allianz between 1980 and 1989, on average
significantly. Extreme rains, heat waves, cold snaps, $15bn a year was paid out in insured losses for such
blizzards, floods and droughts are just some of the many events around the globe. This has risen every decade to
weather events that are impacting how people live, hit $40bn a year on average between 2000 and 2009.
what they buy, where they go and how their business Most recently in the three years from 2010 to 2013 alone,
performs. $70bn in damages from these weather events has been
paid out annually.
Climate change is often cited as the main driver of such
weather patterns. Skeptics may disagree but whether This last figure counts the cost of 2013’s central
you are a believer or not insurance companies have the European floods which saw heavy rainfall cause damage,
bills that show damages from extreme weather events resulting in economic losses of close to $18bn, claiming
are rapidly increasing. 22 lives.
6
The weather business
In 2012 alone, the US suffered 11 weather-related
What is weather risk management?
catastrophe events that each caused at least $1bn in
damage, according to a study by the Stanford Woods
Weather risk management is the management of
Institute for the Environment.
financial risks that are directly- or indirectly-linked to
the occurrence of an observable weather event or
Meanwhile, the US Department of Commerce estimates
variability in a measurable weather index.
70% of companies are directly affected by the weather
with the US Climate Disruption Budget in 2012 totaling
Different industries may respond to similar weather
nearly $100bn. The federal government spent more
perils in different ways and this is one of the many
taxpayer money on the consequences of the volatile
reasons for the unconventional nature of the business.
weather activity during 2012 than on education or
transportation.
For example, although heavy snowfall will most
likely hurt the profits of an airline, it is going to
Global economic losses from weather-related events
help the snow removal company and the de-icing
came to about $150bn in 2012, according to Munich
operations at the airport.
Re. However, in addition to the high-profile natural
catastrophe events there is also a huge variety of
Effective weather risk management helps
increasingly volatile weather activity, such as changes
companies take control of financial impacts that
in temperature and levels of wind, rainfall, snowfall and
may result from adverse weather conditions.
even the amount of sunshine, which can significantly
impact the balance sheets of businesses, even if these
only constitute minor deviations from the mean.
Shareholders, analysts, lenders and rating agencies have
become increasingly aware of the possibility of including
Unfavorable weather
weather protection in a company’s risk management.
no longer an excuse
While companies cannot expect to control the weather
It is clear that deviation from normal weather can they are now expected to understand the impact of it
adversely affect the financial performance of most on their business in order to make an educated decision
companies. Unforeseen or abnormal weather patterns how to insulate unwanted weather risks to better control
$100bn have the potential to disrupt businesses in a number
of sectors via a host of climatic perils. Many financial
the risk of its financial impact.
concerns may find their income streams affected by the Traditionally, companies were of the opinion that there is
weather, both directly or indirectly. nothing they can do to combat the negative effects of
US government’s annual
climate disruption budget the weather. For example, construction companies are
But “bad” weather is no longer a sufficient excuse for vulnerable to delayed project completions, airlines fear
volatile revenues, higher costs or disappointing earnings. cancelled and delayed flights, retail stores are disappointed
Financial statements are awash with comments blaming when a cold summer or a warm winter changes
poor performance on weather – this is increasingly less consumer behavior in terms of seasonal items. Today, all
accepted by stakeholders. of these risks can be mitigated via coverage structured
through the weather risk management market.
The more people are aware of the opportunities in
“Companies have been weather risk management and take advantage of them by
incorporating them into their overall risk management
of the opinion nothing systems, the better the execution can become.
could be done to combat
the negative effects
of the weather”
7
INTRODUCTION
Introducing weather risk management products
According to the Weather Risk Management
Association (WRMA), these products have been in
existence since the late 1990s. They focus on the
use of weather data – measurable weather variables
such as temperature, precipitation, sunshine,
snowfall and wind – as the basis for risk indices,
which make weather risk fungible.
With no physical damage required for a payment
to be made, weather solutions have the advantages
of simplicity, lack of ambiguity and speed of
settlement.
Using commercially-available data from
meteorological offices around the world, these
Meteorological data is crucial
custom-made products can help to smooth financial
volatility, enhancing economic value for companies.
The second critical element to the advancement of
weather risk management solutions is the availability
For example, energy companies want cold winters
and accuracy of historical weather data. There are
and hot summers and protect themselves against
meteorological weather stations all over the world
unfavorable seasons to safeguard revenues. Wind
and technology has advanced the use of satellites. It
farm operators seek protection against low wind
is important that the weather data has been recorded
levels to protect their financing. Meanwhile, a strong
at, or close to where this is not possible, the location of
correlation exists between precipitation, frost or fog
the risk in order to avoid basis risk – a different weather
and flight delays so airlines would look to protect
measurement at the weather station than the actual
themselves against the impact of changes in such
weather experience at the risk location.
weather patterns. These conditions can also impact
other modes of transportation.
Crucially, unlike with traditional insurance solutions,
physical damage is irrelevant for the cover to be affected.
The loss that is covered is one of a financial nature.
Settlement is objective. Tailored weather risk
management solutions are transparent, easy to
understand and promise fast payout of any claims,
addressing what are often cited as being the key
weaknesses of traditional insurance products.
“Unlike with traditional
This report examines the impact increasingly volatile
weather activity can have across a number of different insurance, physical
business sectors.
damage is irrelevant”
Weather risk management solutions are set to become
an increasingly important component of the risk
manager’s toolbox, enabling companies to hedge the
risk posed by such fluctuations in a manner similar to
the way companies already combat the threat posed by
interest rate and foreign currency exchange movements.
8
The weather business
WEATHER AND
BUSINESS
Exploring the link between
weather and business
Recent events around the globe underline the increasing volatility of the weather and the
different ways in which they can impair the economy. Although the majority of businesses
are exposed to weather risks, many are still failing to adequately identify and manage the
impact changes in climatic conditions can have on their revenue streams
A strong correlation exists between snow, frost or fog and flight delays
Headline-grabbing weather events such as cities sweltered. The summer of 2012 was a season of
“Snowmageddon” in the US, which delivered an epic proportions, especially July, the hottest month in the
unexpected 36 inches of snow to the Washington DC history of US weather record-keeping, according to the
region over just two days in February 2010 and the Stanford Woods Institute for the Environment.
record levels of flooding in Queensland, Australia which
besieged an area larger than France and Germany later At the same time, on the other side of the Bering
that same year are typically used as examples of how Strait, large parts of Russia were also suffering from a
recent years have been witness to increasingly volatile prolonged drought.
weather patterns around the globe. Unfortunately, there
are many others. Meanwhile in the UK, 2012 was officially the wettest summer
on record. However, a year later the UK summer was the
During the summer of 2012 the US went from one driest on record, coming hot on the heels of its coldest
extreme to another. Drought shriveled crops in the spring on record, according to the Meteorological Office.
Midwest, wildfires burned in the West and East Coast
9
WEATHER AND
BUSINESS
REPORT
Bad weather underestimated by UK business
According to the Chartered Management Institute (CMI) severe weather is the major cause
of disruption to British businesses, yet managers continue to underestimate it as a threat.
Although identified as the top cause of business disruption for three consecutive years, the CMI said in its
“Weathering the storm” report that companies still risk not having plans in place to reduce disruption caused by
snowfall and are underperforming as a consequence.
Heavy snowfall in 2012 severely impacted UK businesses with managers estimating the average cost at £52,000,
with some claiming losses up to £1m. As many as 77% of organizations were adversely impacted by the snow,
with travel conditions and childcare issues preventing staff getting to work. Yet bad weather barely made it into
the top 10 risks impacting their business.
This pattern of volatile weather activity continued The economic impact
through 2013 with record amounts of rainfall resulting
in flooding in the state of Colorado. The city of Boulder Such events are used to illustrate increasing
received so much rain that it broke its yearly record for unpredictability in the weather because they provide a
precipitation with three months remaining of the year. graphic illustration of the significant impact they have
Balloon recordings from Denver measured the highest- on economic and commercial activity in a number of
ever level of September moisture for the station, with different ways.
the amount of rainfall classified as being likely to fall less
than once every 1,000 years. For example, in the case of “Snowmageddon” schools,
businesses and governments were closed, while more
Across the border in Canada the torrential rain that hit than 24,000 flights were cancelled. Although the Wall
Southern Alberta in June caused flooding resulting in the Street Journal reported that the cost to airlines was
costliest insured disaster in the country’s history. believed to be less than $10m – constituting a lucky
escape in this instance – it also noted that the economic
And elsewhere in the Americas region, in July unseasonal output of the area stretching from Washington to New
frosts occurred in southern Brazil with over half of the York City is $10.1bn a day. If a day of economic activity is
South American country’s 590-million-ton agricultural lost entirely as a result of a storm it is estimated it would
crop still awaiting harvest. knock 0.28 percentage points off a quarter’s annual rate
of growth in GDP4.
“Severe weather events Meanwhile, with regards to the flooding which impacted
Queensland in Australia, the state accounted for
are often insured against approximately 20% of the Australian economy, 60% of
global coking coal exports and 28% of Australia’s fruit and
while seasonal fluctuations vegetable production, according to analyst IBIS World.
in climatic conditions As a result of the flooding forecasted GDP for 2010-11
are not” was cut from 2.9% to 2.6%. The floods also resulted in
A$2bn in lost coking coal production while an estimated
A$1.6bn worth of crops were lost.
10The weather business
In the case of the US drought, soybean production Meanwhile, this year’s Colorado floods are already believed
decreased by 12%, while core production fell by 13% to its to have cost the state’s economy $2bn, while economic
lowest level since 2006, according to the Department of losses from the Canadian flooding could hit C$5bn.
Agriculture. Insured crop losses were almost $12bn and
overall GDP suffered as a result. And the Brazilian frosts are believed to have damaged
around 65 million tons or 18% of the unharvested cane
Credit rating agency Standard & Poor’s has predicted crop in the region, according to agricultural researcher
that weather events like extensive droughts or high Datagro Ltd. They could even affect next year’s harvest
temperatures will have a negative impact on credit too, with the worst-impacted areas being the states of
ratings of corporations and institutions that are affected. Parana, Mato Grosso do Sul and Paranapanema Valley in
A lower credit rating will result in higher borrowing costs. Sao Paulo.
In a similar vein, the Russian drought ruined over 7.5% As a result of these frosts Brazil is set to suffer a significant
of the country’s annual harvest, according to its Ministry reduction in its sugar exports, with Reuters reporting that
of Agriculture, while the UK’s washout summer of 2012 they would also cause significant losses to the current
saw the country’s entertainment and tourism sector take season’s wheat crops and next year’s coffee crops.
significant hits as sports events and music festivals were
all cancelled. At one point it even threatened certain It has been estimated that Parana, one of Brazil’s top
events at the London Olympics with two waterlogged two wheat-producing states, will lose 33% of its current
venues – Eton Dorney and Greenwich Park – having to be wheat crop, bringing current expected output to 1.9
hastily resurfaced prior to the start of the games, leading million tones.
to fears that the rowing, canoe, equestrian and modern
pentathlon events could be interrupted or delayed.
Economic impact of weather events around the world
Canada flooding Germany/CE floods
June 2013 June 2013
Record insured loss of $2bn $18bn economic loss
Russia drought
July 2012
7.5% of annual harvest ruined
Snowmageddon US
February 2010
$160m spent on snow removal
Australia floods
December 2010
Brazil frosts
A$2bn in lost coking coal production
July 2013
65 million tons of cane crop damaged
Source: AGCS5
11WEATHER AND
BUSINESS
Meanwhile, 62% of 2014’s coffee crop could be lost,
roughly equivalent to 1 million 60-kg bags. Output is now
seen at 582,000 bags from the state, down from 1.54
million previously. Around the time of the bad weather
in Brazil, the price of sugar jumped almost 3% to 16.92
cents a pound, the Financial Times6 reported, correcting
two years of steady price decreases in the wake of large
harvests in the country, which is the world’s largest sugar
producer. And all because frosts arrived a couple of
months later than expected.
Minor weather fluctuations hit
the bottom line
Events such as the ones mentioned above offer evidence
that volatile and unpredictable weather patterns are
increasing around the globe. However, weather activity The energy sector has been an early adopter
of weather risk management solutions
does not have to be so extreme or have such wide scale
impacts as these examples to impair company cash flows.
Many companies protect themselves from risks posed
by price, currency or interest rate fluctuations through
hedging instruments. However, weather-related risks
are largely self-insured by most companies, either
because they are not aware of the magnitude of the
risks or because they are not aware of the possibilities to
effectively protect against the weather.
Indeed, weather-sensitive risks linger at the bottom of
a Deloitte7 index focused on the major risks causing
corporate crises. Yet weather is actually embedded in the
number one cause of a corporate crisis identified in the
same study – demand shortfall.
And while the consequences of severe weather events
are often insured, seasonal fluctuations in climatic
conditions are not.
Some companies are aware of weather risk solutions but
consider the cost to be too expensive – until they are hit by
a major disaster. However, this does not have to be the case.
The cost is a function of the historical volatility and the
payout triggers. For example, protecting against a one-
in-three year event is more expensive than covering a
one-in-10 or 20-year event.
Both make sense. The former may be considered an
income volatility management tool, while the latter is a
worst-case scenario protection.
Unseasonal frosts can impact crops such as coffee
12The weather business
WEATHER
VARIANCES
IMPACT
Heavy snow can impact revenues in the food and retail sectors
Impact of weather variances
on businesses
Sectors such as energy, retail, food, clothing, tourism, distribution, transport and
construction are just as sensitive to minor changes in the weather as they are to
movements in interest and foreign exchange rates in terms of the impact this can have on
profits. Weather risk management solutions have an increasingly important role to play in
enabling companies to protect themselves effectively against such risks
At the macro level it is estimated that $5.7trn of the Using the same methodology for the European Union
$/€ exchange rate as of
October 24 2013 $15.7trn in US GDP is sensitive to the weather. Moreover, (EU) countries we can approximately assume that
according to the National Center for Atmospheric $5.9trn of the $16.5trn in GDP of the EU is sensitive to the
Research (NCAR) and the National Science Foundation weather, based on 2012 figures. Similarly routine weather
(NSF) the impact of routine weather variance on the variation on the EU’s economy would cost approximately
economy is a much as 3.4% of US GDP or $534bn, based $561bn (€406bn).
on 2012 figures.
Variations in the weather can impact a company’s
The NCAR and NSF study was the first to apply quantitative financials from the supply or demand side, as well as
economic analysis to estimate the weather sensitivity of from operational exposures (see box on page 14). While
the entire US economy. The impact of routine weather volatile weather activity can have a significant impact
variance on the economy does not calculate additional on companies in all sectors some are more sensitive to
costs associated with extreme weather events such as weather than others such as energy, retail, food, clothing,
outbreaks of tornadoes, for example. tourism, distribution, transport and construction.
13WEATHER
VARIANCES
IMPACT
The energy sector is currently undergoing significant
Weather can impact a company’s financials in
change, as across the developed world governments try
the following areas:
to switch from traditional sources, based on fossil fuels
or nuclear to renewable sources, including wind, solar
Supply Risk
and biomass. For example, Germany’s much-vaunted
Scenario: Lack of wind significantly impairs power
decision to abandon nuclear energy and move over to
generation and, potentially, the ability to fulfill financing
30% from alternative energy sources, such as wind farms,
commitments, Annual wind power generation can
by 2020 means its economy could be vulnerable to a lack
deviate by more than 20% from the long-term average
of wind or sun hours, despite feed-in tariffs.
Other examples:
Warmth for plant growth
And it is not only a lack of wind that can cause problems
Water for hydropower
for turbines, excess wind – particularly during the
construction phase of offshore wind farms – can trigger
Demand Risk
delays in start-up and downtime in the construction
Scenario: Mild winter impacts car battery sales –
program.
sales of many retail products are highly sensitive to
the weather. For example, an automotive company
sells more batteries during cold winters than during
warm ones.
Demand and operational risk
Other examples:
The weather can also significantly impact the fortunes
Mild winter also impacts coat sales
of the retail sector, with both better than expected
Hot summers increase beverage sales
and inclement weather having the potential to keep
Rain affects vacation bookings
people away from shops for different reasons, posing
both demand and operational risks. Sales of many retail
Operational Risk
products are highly-sensitive to the weather.
An array of weather issues cause travel disruptions.
The aviation sector is vulnerable to weather perils
For example, sunny weather during the summer could
such as snow and ice. Airport and airline operations
mean people go to the park or beach rather than
rely heavily on correct schedules and punctuality.
shopping, impacting those companies who sell the
Hub operations are especially vulnerable
majority of their goods right before the holidays.
Other examples:
Meanwhile, in the US, inclement weather, particularly
Low rivers impact barge transportation
in the five week period following “Black Friday”, which
Cooling of manufacturing plants – excessive heat
is the day after Thanksgiving and heralds the start of
can negatively impact workers, production levels
the Christmas shopping season, can present a serious
and quality of goods.
risk to retailers because adverse weather conditions can
prevent consumers from getting to the shops at a time
when retailers usually expect to see a surge in sales.
Energy companies are particularly vulnerable to
variations in temperature because they cause fluctuations Unexpectedly volatile weather can also cause a number
in demand. They desire cold winters and hot summers. of operational issues for other businesses such as travel
disruption with the aviation sector being particularly
For example, Dominion, which is one of the largest vulnerable (see box on page 15).
producers and transporters of energy in the US, with a
portfolio of approximately 27,400 megawatts of generation, In addition, snowfall can cost municipalities millions
11,000 miles of natural gas transmission, gathering and of dollars in lost revenues with costs incurred from
storage pipeline and 6,300 miles of electric transmission the gritting of roads in order to clear up, as well as lost
lines, revealed in 2012 that its third quarter earnings were income from tolls and taxes.
down by nearly a half of what they had been a year
earlier due, in part to “milder than normal weather”8.
14The weather business
The cost of the weather on business
Routine weather
variance on the US Routine weather
economy is as much as This equates to variance costs the EU
3.4% of GDP
$534bn €406bn
Weather is the cause of approximately of the delays in the National
70% Airspace System (NAS).
1 , –4 ,
Weather is responsible delay hours per month in the
for approximately National Airspace System
The total weather impact is an estimated national cost of
for accident damage and injuries, delays, and unexpected operating costs. off
ior to take
76% are pr
ich
h
o fw
o ut
84% of all delays occur on the ground (gate, taxi-out, tax i-in),
$2.2bn to $3.5bn
Cost of weather-related delays to trucking companies per year
12% $22.4
or
bn
$187 Total value of annual output of
bn agricultural sector in the US
Adverse impact routine weather variations have on this economy each year
Sources: National Science Foundation, AGCS, Federal Aviation Administration, US Department of Transportation 9
15WEATHER
VARIANCES
IMPACT
The construction industry is vulnerable to operational “Weather risk management should be added into this
risk resulting from variances in the weather as freezing mix to make it state-of-the-art and up to par with the
temperatures and frost can incur significant project demands of stakeholders,” explains Karsten Berlage,
delays, as well as spiraling costs. Global Head of Weather Risk Management at Allianz Risk
Transfer.
In short, there are a plethora of examples of weather
risk impacting business. Hydro-energy, travel, leisure, “Today, although many companies are comfortable
entertainment and mining are all highly-susceptible to hedging a number of different risks and are increasingly
variance in precipitation. Meanwhile, food and beverage focused on operational, legal and regulatory challenges,
providers may find their sales either increasing or they are neglecting weather risk, which is often the main
declining depending on temperature extremes, while contributor to profit volatility,” he continues.
a lack of sun will almost certainly dent the business of
holiday companies and tour operators. “However, there are changes ahead in terms of the
allocation of resources that the risk manager will have at
his disposal when it comes to addressing the different
Weather changes as a core risk to
risks facing the company in the future. I can see a big
business performance shift towards including weather risk management.
Yet despite the increasing amount of evidence, many “We are already seeing companies who are proactively
businesses, municipalities and governments are either managing weather risks effectively benefit from lower
failing, or not doing nearly enough, to identify the link financing costs and better budgeting and planning. They
between variations in climatic conditions and their own may even use it as a sales tool in terms of stakeholder
revenue streams, or indeed to protect themselves against management,” he continues.
the considerable risks such scenarios present.
“These companies will be able to show they have
The weather needs to be defined in such a way that mitigated key risks, protected revenues and reduced
it describes a business risk. A failure to do so means profit volatility, making themselves more attractive to
that businesses are missing the opportunity for better investors.
cash flow stability, allowing more accurate budget
management and ultimately higher risk-adjusted “If analysts are aware that firms are addressing these
returns. risks proactively, then the money spent on such solutions
will be more than offset by the reward of higher
In today’s global markets, where competition for capital shareholder value,” he concludes.
is intense, there is an increasing sentiment that companies
can no longer get away with blaming the weather for Conversely, in the future, those weather-sensitive
poor sales or profit performance, especially when there is companies who refuse to deploy weather risk solutions
a growing awareness that there are ways of dealing with could suffer negative consequences from stakeholders.
this. Shareholders are becoming more aware that
potential solutions such as weather risk management
products are available. And they are going to insist that “Weather-sensitive
the management they have put in place takes a more
active role in managing weather-related risk. companies who don’t
Traditional risk management has a number of different deploy risk solutions
components such as risk assessment and analysis,
monitoring and control and long-established mitigation
could suffer negative
solutions such as captives or traditional insurance
products.
consequences from
stakeholders”
16The weather business
PROTECTING
FINANCIAL
PERFORMANCE
Rain can impact holidays sales and bookings
Protecting financial performance
Deviations from expected weather patterns need to be considered in the context
of risks and opportunities. Some businesses have clear exposures to certain
weather perils; for others evaluating weather risk may require deeper analysis of a
combination of perils. Various risk management coverages can be structured for
an increasing number of scenarios
There are a number of different areas in which the “The first line of defense might be the desire to protect
risk manager who takes the risk posed by unexpected against too much rain or excess temperatures, as and
changes in the weather seriously can reap benefits. when they hurt a company,” he continues. “However, this
can be expensive, if historical weather measurements
These include helping to deliver improved returns, indicate a high probability of such weather events
therefore bolstering equity valuations and revenue occurring.
certainty, ensuring forecast reliability. Improvements in
financing can lower the cost of capital while protecting “Alternatively, companies can give up partial upside
revenues from weather fluctuations helps ensure in order to reduce the price of the weather cover. This
liquidity. structure is sometimes referred to as a ‘collar’. It reduces
volatility risk and requires less upfront payment than a
“Weather risk management extends beyond the need to pure downside protection.”
cover downside risk,” says Karsten Berlage, Global Head
of Weather Risk Management, Allianz Risk Transfer.
17PROTECTING
FINANCIAL
PERFORMANCE
Weather risk management solutions for the alternative energy sector
As an example, a wind farm that generates more power “Then there would be limited, or even no, upfront
than anticipated due to steady, strong wind could give premium necessary,” says Berlage.
up some of its higher returns to help smooth earnings
during periods when the wind fails to blow. Weather risk management protection is especially
critical in the alternative energy sector, where there is
Instead of just having a “put” option against a lack of a considerable use of debt and some lenders require
wind a “collar” structure is created for excess wind. So, resource protection before granting funding.
for example, if 100 points is the 30-year average of wind
speed on the index and the wind registers over 110 points, And it is obviously an essential tool in areas such as wind
the insured would pay the excess and if it is less than 90 farms where the business relies on one weather-related
points a payout would be received (see chart below). factor – that the wind blows – in order to generate income.
Supply Risk
Lack of wind impairs power generation
Lack of wind significantly impairs power generation and, potentially, the ability to fulfill financing commitments.
Annual wind power generation can deviate by more than 20% from the long-term average. Allianz Risk Transfer
weather solutions can manage short- and long-term risks at a single location or over a portfolio of assets. They
cover everything from extreme scenarios for project finance security to utility-scale production, resulting
in more stable cash flows from existing and planned operations. Allianz Risk Transfer’s supply side weather
solutions protect clients from revenue deterioration and volatility and improve their creditworthiness.
Tailored Strategies
• Uncovered production (blue line). Covers may be structured in different ways to:
• Purely protect the downside, e.g., lack of wind (yellow line)
• Manage volatility while limiting premium outflow (green line)
120
110
Percent
100
90
80
70
1975 1980 1985 1990 1995 2000 2005 2010 2015
18The weather business
How is coverage for weather risk developed?
Putting together effective, tailored risk protection covers is straightforward and transparent.
1 - Identify revenue and/or profit volatility
- Collect and analyze historical sales data
2 - Gather historical weather data at the relevant locations
- Identify weather stations near location to minimize basis risk (difference of weather experience between
client site and weather station)
- Contract “clean” weather data
3 - Build a tailored weather index to match revenue sensitivity
- Compare regional company and weather information to build relevant correlations
- identify specific weather sensitivity to sales and profits
4 - Structure alternative weather covers to smooth downside sensitivities
- Either more aggressively or focus on worst case scenarios
5 - Agree on deal structure and transaction terms
6 - Close transaction at least two weeks prior to risk period
7 - The whole process can be finalized in a short period of time
Weather risk management solutions for the agricultural sector
Meanwhile, in the agricultural sector, although traditional and sometimes payouts take two to three years to be
insurance products, such as crop insurance, which can settled after a loss.
cover a number of perils including pesticides, fire and
misuse of fertilizer, are readily available, weather risk “In the case of weather risk management solutions, the
management solutions are also increasing in importance. payout can be made within days, so the farmer gets the
Failed crops: weather money, while the lack of revenue is still an issue,”
risk management At first glance it might appear the farmer is better off Berlage adds.
solutions have some key
advantages over crop with a traditional crop insurance policy as it covers a
insurance basket of different risks. “Moreover, the process of determining a loss is objective
because the criterion is determined by the actual rainfall
However, for example, a wheat farmer is exposed to or the temperature observed throughout the season, for
frost during planting, excessive heat during growing example. This ensures the product is transparent and
and excessive rain during harvest. These are the main easily measurable.
determining factors whether a harvest is good or not.
“With crop insurance a farmer who knows midway
“If you ask farmers about the vulnerability of their crop, through the season that the crops are damaged has
many will say the fertilizer can be controlled and that no incentive to minimize the loss. With a weather
there has never been a fire, so what it comes down to is risk management product they receive the payout
that the weather is the biggest risk,” Berlage says. irrespective of the actual harvest. Hence, the farmer
is still able to try and maximize the yield of his field by
Weather insurance has some key advantages over crop changing the watering or covering his crops to protect
insurance, he adds. from sun or heat.”
“If you claim on a crop insurance policy, a loss adjuster It should come as little surprise then to find that farmers
will determine how large your loss is, which is a rather have been among the early adopters of weather risk
subjective process. There can be arguments, legal battles management solutions.
19PROTECTING
FINANCIAL
PERFORMANCE
Shoppers on “Black Friday” - the day after Thanksgiving and start of the US holiday shopping season
Solutions that follow the revenue streams
Some businesses have clear exposures to certain “Index-based products are very good at following
weather perils; for others evaluating weather risk revenue streams and they require little or no proof of
may require deeper analysis of a combination of loss. They are quick to settle,” explains Dan Tomlinson,
perils. For example, airlines and airports require wind, Managing Director at Allianz Risk Transfer.
temperature, precipitation and visibility to be within
normal parameters in order to function without delays at “They are an efficient mechanism for risks that are
different locations around the world. closely aligned to some underlying index, as opposed to
the traditional insurance world, which tends to look at
In such a scenario it is possible to create a tailored the more extremes of losses, damage etc.”
weather index comprising multiple perils to reflect
the varied risks involved. Various alternative weather For example, in the case of a US jewelry chain seeking
coverages can be structured to protect against an protection from the prospect of poor weather impacting
increasing number of scenarios. revenues during its anticipated busiest sales period
during the Christmas shopping season, Tomlinson says
Most important is the focus on analyzing the company’s Allianz Risk Transfer would calculate the index and
weather protection requirements, the risks faced and its explain what the correlations are between the different
risk appetite, before selecting, structuring and executing weather stations that have been selected to monitor the
the most appropriate solution depending on the chosen peril, usually snow or heavy rain, and how this has
suitability of the counterparty. been put together, so there is no misunderstanding of
how a claim might arise.
“With weather risk “Then we calculate the probability of that happening,
based on, for example, precipitation in the past at the
management solutions weather stations in question,” adds John Arpel, Managing
Director at Allianz Risk Transfer.
payouts can be made
“Quite often we can go back 20, 25, 30 or even up to 50
within a few days” years to get a probability.”
20The weather business
Uses of weather risk management solutions around the world
Protecting maize crops in Benin –
Maize crops go through three distinct phases, one being the germination of
the seed, the second being the growth of the plant and third being the time
just before the crop is harvested.
Weather risk management products can help protect against variances in
weather that can determine whether it is a good harvest or not.
Protecting the cost of keeping roads clear in Budapest –
The municipality has enquired about operational cover, protecting it from the
cost of salt it would have to put on the roads to help keep them clear in the
event of a very cold winter.
Protecting against falling jewelry and snowmobile sales in the US –
As US retailers increasingly worry over the potential to miss out on the “Black
Friday” sales bonanza that heralds the start of the Christmas shopping season
in the US, a chain of jewelry stores has taken action.
“The jewelers wanted cover because if the weather is really bad on that day,
people won’t go to the mall and buy,” explains John Arpel, Managing Director
50% at Allianz Risk Transfer.
“The jewelry chain assessed their average takings on ‘Black Friday’. If it rains
above a certain level, which is likely to prevent people from going to the mall,
Percentage of annual then they are protected by the prospect of a payout.”
profit a UK jewelry chain
estimates is delivered in
December “Similarly, another store in the US, which specializes in selling snowmobiles is
looking to protect itself in the event of a particularly warm winter because
people don’t buy or service their snowmobiles.”
25% Innovative solutions
Weather risk management products are becoming “Frost Day” covers represent a cost-control solution
Percentage of annual
profit delivered in the increasingly innovative in their approach as the product whereby purchasers receive an automatic payout if
week before Christmas and its applications continue to evolve, offering a variety a predefined parameter for the number of frost days
of tailored solutions to sector-specific issues. is met. By using “Frost Day” covers, a construction
company can minimize its financial risks. Over a number
For example, in the Netherlands, labor agreements of years, Dutch companies have taken out several
£3m
prevent construction workers from working in freezing million euros in coverage to prevent losses from severe,
temperatures. If temperatures are below freezing at key sustained cold weather, thereby protecting profits from
times, construction workers are not allowed to be on site being adversely affected by the weather.
and must be sent home with pay. If the freezing weather
is extensive, the cost of wages and lost production
Total cost to the business
from heavier than can be extremely detrimental to a company’s income
expected snowfall statement. A solution to the problems faced by the
preventing customers
European construction industry is the use of “Frost Day”
getting to the shops
during this period covers to offset the impact of cold weather on revenues.
source: WRMA 2013 conference10
21PROTECTING
FINANCIAL
PERFORMANCE
Promotional offers like “Sunshine guarantee”
New solutions mean there is now an upside to weather Payouts are triggered using data from a local weather
risk too, with the possibility to use it as a promotional station in the state where the car is registered. The cost
tool to boost a company’s sales. Weather promotions of the cover might be subsidized in full, or in part, by
can be used as a creative marketing weapon to drive the car company, or the cover might be offered to the
sales of anything from snowmobiles to sandwiches. For customer as an option.
example, a car company looking to use weather solutions
for promotional purposes may entice potential buyers of “Ultimately, if the client has a reasonable idea already of
convertibles with a “sunshine guarantee”. how the weather affects their business then we know
we have got something to work with,” says Tomlinson,
A consumer may be protected against a lack of sunny explaining the first steps in putting a weather risk
days to enjoy having the roof down. For example, they management transaction together.
may receive €100 as compensation for every rainy day
after a defined threshold.
“Index-based products
are very good at following
revenue streams”
Weather risk management solutions can be used to protect convertible owners against a lack of sunny days
22The weather business
“The first approach is: what is the intuitive risk? Once Combining weather perils with
you have established the intuitive link to the weather it other risks
becomes much easier to identify precisely what kind of
weather. This is the conversion of ideas such as nice and Meanwhile, Tomlinson says there is increasing interest
nasty to cold and wet when thinking about the weather. from businesses who want to cover “a whole basket of
“We always listen to the client’s description of how they hitherto uninsurable risks in one bucket”.
view the risk and its core factors,” he continues.
“There might be the risk that you have to pay property
“We are trying to represent cash flow timings that matter deductibles if, in the case of a wind farm for example,
to the client and capture the moments they don’t like. there is a property event but in addition to that there is
We need to be sure what levels of basis risk we are also the possibility of a lack of wind which also needs to
encompassing. We need to have a good understanding be protected against.
of how they can affect the end result and we need to be
comfortable that they are within our tolerance.” “Quite often, these coverages can significantly de-risk
their whole project.
“We can tailor a package of other covers including a
weather cover,” Tomlinson says, adding that multi-peril
structures can also incorporate weather risks plus a
regulatory risk or equipment warranty, for example.
Weather risk management solutions – selected industry applications
Industry Potential Product Applications Allianz Risk Transfer Approach
Agriculture • Variable crop yield • Activities in Australia, US, Europe, India
• Handling, storage • Alternatives to crop insurance
• Strong growth expected
Construction • Delays • Frost Day product in the Netherlands
• Incentive clauses • Wave height offshore
Energy (Traditional) • Fluctuating demand • Multiple transactions (US, Europe, Australia)
• Generation mix • Single and double trigger
• Strong demand for warm winter protection • Seasonal and multi-year
Energy (Renewable) • Fluctuating supply, not a “free resource” • Wind and solar offerings
• Multi-year deals (US, Europe, Australia, India)
• Multi-peril structures • Multi-year deals, comprehensive data analysis
• Operators and capital providers
Entertainment/ • Postponement • One-off deals
Amusement Parks • Reduced attendance • Tailored program deals
Transportation • Budget overruns • One-off deals
• Delays • Growing sector
• Cancellations
Retailing, Food & Drink • Reduced demand of weather-sensitive products • Tailored indices for clients in US and Europe
• Increased raw material costs • Growing sector increasingly aware of product
advantages
Municipalities • Snow covers • Budget constraints and weather volatility aid
• Flooding product awareness
23PROTECTING
FINANCIAL
PERFORMANCE
Lack of understanding about weather impact
There may also be tax and regulatory issues to consider, “It is one of the reasons that utility companies have
depending on the jurisdiction of the insured. Regulators been the biggest adopters of weather risk management
prefer those using hedging techniques or trading to products, because for them it is pretty straightforward. If
have experience of those methods and sophisticated risk it is warm all winter people won’t turn their gas on. That
management functions. is pretty interpretable and straightforward. People use
more gas when the temperature goes below 65°F so that
“Most companies don’t have a very good understanding is obvious,” he concludes.
of how those weather variables move together to stop
them selling products,” adds Barney Schauble, principal, The energy sector measures deviations above and below
Nephila Capital, which is the largest institutional asset 65°F as cooling and heating degree days (CDD and HDD
manager of vehicles dedicated to investing in natural respectively) and energy producers will seek to use these
catastrophe and weather risk. to protect themselves against warm winters and cold
summers.
“In order to come up with a customized product we
need to understand what it is they do and what their
relationship with the weather is.
“Then we can structure a contract and match it with “How good is a company’s
another contract. There is a basic structural challenge,
which is how good is a company’s understanding of its understanding of its
exposure to weather? Sometimes it is complicated as it is
hard to figure out the relationship,” he says. weather exposure?”
Weather challenges and structured solutions
Aviation Agriculture Snow
Challenge of airlines: Challenges in agriculture: Challenges of snow removal
• E xpense due to seasonal weather • Farmers and agricultural • Municipalities and corporations
delays, particularly at hub airports companies bear financial risk from bear costs of snow storms due
• S trong correlation between yield variability to snow removal, business
precipitation at the hub and total • Excessive/insufficient rain and interruption and lower income
weather delay minutes temperatures • Snow removal budgets tend to
• Different sensitivities during be constant. Snow experience is
Indicative structure planting, growing and harvest highly variable
• 1 0-year annual precipitation seasons
Indicative structure
average for Chicago O’Hare is 35”
Cumulate snowfall
• 1 0-year standard deviation is 5” Indicative structure
Period: December 1 – March 31
• T o cover extreme years, a structure • Regression analysis of crop
Station: Central Park, New York
may pay for each .25” over 40” yields and weather variables,
Strike: 35 inches of cumulative snow
precipitation for example, precipitation and
temperature Alternatives
Alternatives • Index optimized to historical yields Single storms versus annual totals
Snow storms, fog, high winds Benefits
• Budget certainty
Benefits • Savings
•C
over cost of delayed flights
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