Weather Insurance or Weather Derivative Two Solutions for Weather Risk
One need not search far to find extensive materials
advocating the use of weather risk management tools to manage risks associated with temperature, snow, precipitation or wind speed extremes. However, most of these materials fail to point out that weather risk management tools come in two forms—traditional insurance products or derivatives, a more recent development from the financial services industry. While both accomplish the same objective, their characteristics are not always the same.
In general, derivatives are considered a more sophisticated, but currently less regulated risk management tool than insurance. Given this, some purchasers prefer to utilize insurance as most are familiar with this type of risk mitigation tool and may find comfort in its significant regulatory requirements. Insurance does, however, lack some of the flexibility associated with derivative-based solutions. The following chart summarizes the key differences between insurance and derivative weather risk management products.
| ||Weather Insurance || ||Weather Derivatives |
|Eligibility to Purchase ||No minimum eligibility standards, although Vortex only offers commercial line policies at this time (no personal lines) || ||Must meet certain financial sophistication eligibility standards, typically must have at least $10 million of assets or $1 million of net worth |
|Accounting and Tax Treatment ||Premiums typically expensed over policy life, recoveries not typically a taxable gain || ||Treated as an investment, typically valuated using mark to market and recoveries generally create a taxable gain |
|Liquidity ||Illiquid, effectively a buy and hold instrument; Coverage is non-cancelable || ||Greater liquidity than insurance, standard contracts are traded on an exchange, not necessarily a buy and hold instrument |
|Flexibility ||Limited to the purchase of insurance covering measured weather element or combination of elements || ||Can be bought or sold, indexed on a virtually unlimited array of weather variables, no-premium options (swaps, collars) are available as are look-backs and no-claims bonuses |
|Regulatory Controls ||Significant, including state insurance commissioners || ||Currently minimal, sold in many cases under exemptions recognized by the Commodity Futures Trading Commission |
Unique in the industry, Vortex has the ability to offer both weather insurance policies as well as weather derivative contracts. While either type of weather risk management tool provides a mechanism to minimize the risk of decreased revenues or increased expenses caused by weather events, it is important to understand, up front, which type of product is being offered and what is most appropriate for your circumstances. Our goal is to work with you to provide the type of risk transfer vehicle that best meets your needs. Call us today to discuss your unique concerns and learn what Vortex can do for you.
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All clients are advised to seek independent legal and tax advice regarding the appropriateness of a particular risk management solution. Vortex Insurance Agency LLC does not provide such advice, nor does it assume any liability by virtue of the information contained herein; these materials are for informational purposes only.