1 Weather Risk Management Salah DHOUIB Underwriter Paris Re
2 T A B L E Index Based Weather Covers Energy Index Based Reinsurance Humanitarian Aid Market Figures
3 Concept of index based weather covers: Definitions Traditional insurance : Material damage and loss of profit following an exceptional event such as storm, typhoon, flood Covered by usual insurance products with an indemnification of incurred and adjusted losses Index based cover : Risk exposure is based on the strong correlation between company s sales/income/expenses and daily meteorological variations. Payout is agreed and triggered only by a weather index, assuming the index is a good proxy to the exposure.
Concept of index based weather covers: Multiple choice of indices 4 Underlying: Temperature Precipitation : rainfall, snowfall Others : wind speed, relative humidity... Combinations Index: Critical day Mean (weighted or not) Cumulative (with threshold or not) Combinations
Concept of index based weather covers: Key elements of the product 5 A cover is defined by: A period (November to March) An index (cumulated rainfall, HDD, Mean Temp...) A weather station (Paris Orly) A payment structure (Put, Call, Swap, etc) A legal agreement (insurance or derivative) The hedge is tailor made: Index is best proxy to the correlation between the risk exposure and the weather conditions
6 Energy sector example: Heating demand fluctuates in winter (1/2)
7 Energy sector example: Heating demand fluctuates in winter (2/2) Weather risk exposures : Sales decrease when winter is too mild (heating demand) Profitability decreases when winter is too cold (costs) Solution : HDD Put against mild winter and a decrease in sales HDD or CTD Call, against a too cold winter and increase in costs HDD, Heating Degree Day : Number of degrees below 18 C CTD, Critical Temperature Day : Number of days where temperature < 0 C
8 Energy sector example: Wind farm financing secured by wind guarantee Weather risk exposure : Sales are secured and prices are regulated Wind speed is the key factor: power generation is linked to wind speed through the power curve Solution : Index: WPI: Wind Power Index Put : protection against lack of wind ie drop in power generation Financial leverage to decrease the cost of capital Guaranteed minimum income is a security for creditors
9 Insurance or energy example: Marketing Smoothing your Heating/Air conditioning bill Weather risk exposures : When summer is too hot (or the winter is too cold) end user electricity bill increase (Air conditioning/heating demand) Solution : Monthly or seasonal digital protection against a high average daily maximum temperature. (ex $100 if Av. TMax > 30 C) Client pay off: credit on the next bill Guarantee paid by the client or free and provided by the distributor Development of customer loyalty and marketing differentiation
10 Index Based Reinsurance: Wind trigger and intensity of damages Weather risk exposure: Property and motor physical damages due to strong storms are strongly correlated to the wind speed Solution: Annual aggregate excess of loss property treaty 10 weather stations spread all over France Each station has a specific weight Each station has a specific wind speed threshold high enough to capture only strong storms (e.g. 120 Km/h) Each station has a specific wind speed limit high enough from the threshold (e.g. 160 km/h) as to capture storms severity
11 Index Based Reinsurance example: Wind trigger and intensity of damages 40000000 35000000 30000000 25000000 20000000 15000000 10000000 5000000 Wind speed index at a basket of 10 stations (EUR Km/h) Mean = 2,8 ; SD = 3,7 0 1957 1960 1963 1966 1969 1972 1975 1978 1981 1984 1987 1990 1993 1996 1999
12 Index Based Reinsurance example: Wind trigger and frequency of damages Weather risk exposure: Property and motor physical damages due to strong storms are strongly correlated to the wind speed Solution: January-December SL treaty 45 weather stations spread over 5 European countries Each station has a specific weight Each station has a specific wind speed threshold high enough to capture storms (e.g. 110 Km/h) Each station has a specific wind speed limit close to the threshold (e.g. 115 km/h) as to capture storms frequency only
13 Index Based Reinsurance example: Wind trigger and frequency of damages Seasonal Wind speed index (Km/h) at 45 stations Mean = 155 ; SD = 188 1 000 800 600 400 200 0 1956 1958 1960 1962 1964 1966 1968 1970 1972 1974 1976 1978 1980 1982 1984 1986 1988 1990 1992 1994 1996 1998 2000 2002
14 Humanitarian Aid: Ethiopian Structure Target : to establish contingency funding for an effective aid response for the WFP Rapid availability of funds: More efficient Aid Vehicle : based on FAO s crop water balance model and 26 primary weather stations with daily data Structure defined by crop and by weather station.
15 Humanitarian Aid: Ethiopian Structure Location: 26 Weather Stations (Agricultural Areas Only) Start Date: 11 th March 2006 End Date 31 st October 2006
16 Humanitarian Aid: Ethiopian Structure Ethiopia drought Index value 90 000 000 80 000 000 70 000 000 60 000 000 1955 1957 1959 1961 1963 1965 1967 1969 1971 1973 1975 1977 Historique Strike Limit 1979 1981 1983 1985 1987 1989 1991 1993 1995 1997 1999 2001 2003 2005 50 000 000 40 000 000 30 000 000 20 000 000 10 000 000 0
17 Market figures: Distribution of Inquiries, by Sector of Potential End-User (OTC) 2005 Survey 2006 Survey 7% 5% 4% 69% 2% 13% Energy Agriculture Retail Construction Transportation Other 12% 7% 5% 4% 26% 46%
18 Market figures: Number of Contracts (OTC) 5 000 4 000 3 000 2 000 1 000 0 2000/1 2001/2 2002/3 2003/4 2004/5 2005/6 Summer Winter
19 Market figures: Distribution of Total Number of Contracts by Region (OTC) 5 000 4 500 4 000 3 500 3 000 2 500 2 000 1 500 1 000 500 0 NA Asia Europe Other 2000/1 2001/2 2002/3 2003/4 2004/5 2005/6
20 Market figures: Distribution of Number of Contracts by Type (OTC) 100% 80% 60% 40% Other Rain Other Temp CDD HDD 20% 0% 2000/1 2001/2 2002/3 2003/4 2004/5 2005/6
21 Market figures: Total Notional Value (OTC) Millons $ $5 000 $4 500 $4 000 $3 500 $3 000 $2 500 $2 000 $1 500 $1 000 $500 $0 Summer Winter 2000/1 2001/2 2002/3 2003/4 2004/5 2005/6
22 Market figures: Number of Trades on the CME 25 000 20 000 15 000 10 000 5 000 0 2002/3 2003/4 2004/5 2005/6 Summer Winter
Market figures: Total Notional Value on the CME 23 $30 000 $25 000 CME Summer CME Winter Millions $ $20 000 $15 000 $10 000 $5 000 $0 2002/3 2003/4 2004/5 2005/6
24 Weather and Agriculture Covers Team Jean-Christophe Garaix Salah Dhouib David Grégori Nicolas Chatelain Françoise Bollotte E-mail: salah.dhouib@paris-re.com Tel: + (33) 1 56 43 98 31 Fax: + (33) 1 56 43 93 70
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26 Pavillon d Armenonville Thursday July 5 & Friday 6, 2007