Understanding Weather Insurance: Securing Your Business Against Nature’s Unpredictability
The term weather insurance refers to a form of financial protection against losses or damages incurred because of adverse, measurable weather conditions. These conditions generally include wind, snow, rain/thunderstorms, fog, and undesirable temperatures.
Weather insurance is commonly used to protect businesses and their activities. These policies serve various purposes, such as insuring an expensive event that could be ruined by bad weather. Insurers cover insured entities if weather conditions cause a loss of revenue from events.
Key Takeaways
- Weather insurance offers financial protection against losses resulting from adverse, measurable weather conditions.
- Premiums are determined based on the likelihood of the insured weather event occurring and the potential amount of loss.
- Conventional weather insurance covers low-probability but severe weather, such as hurricanes, earthquakes, and tornados.
- High-probability meteorological events can be hedged against via weather derivatives, a financial instrument mitigating weather-related losses.
How Weather Insurance Works
Weather influences our daily lives and can significantly impact corporate revenues and earnings. As a standalone insurance policy, weather insurance is commonly used to protect businesses and their events, such as festivals, concerts, trade shows, seasonal events, parades, film shoots, fundraisers, and sporting events. Individuals can also use weather insurance for major celebrations like outdoor weddings.
Conventional weather insurance typically includes coverage for low-probability meteorological events, including hurricanes, earthquakes, and tornados. Insurers reimburse for losses due to weather conditions causing event revenue loss or event cancellations outright.
The premium for weather insurance depends on several factors, including location and time of year. The dollar amount charged for coverage is determined by the likelihood of the insured weather event occurring and the potential amount of loss. An actuary at the insurance company examines decades of weather data to price a policy accurately.
Purpose of Weather Insurance
Weather insurance is essential for many companies and a crucial risk management strategy. It’s highly customizable, allowing insured parties to select days, weather events, and weather severity covered by the policy.
Businesses sometimes use these policies as promotional tools to attract customers. For instance, a furniture store might offer free purchases if it snows more than two inches on Christmas, backed by a specific weather insurance policy.
Protection against adverse weather conditions is also supported to some extent by other types of insurance policies, such as homeowners insurance, property insurance, or special event insurance.
Example of Weather Insurance
Imagine an event planner organizing an outdoor summer festival. Besides ticket sales, they expect revenue from food, drinks, and product sales. Unsure about cooperative weather, the organizer takes out a weather insurance policy. If rain results in poor turnout, the organizer can claim insurance compensation for lost revenue.
Weather Insurance vs. Weather Derivatives
Historically, companies relied on insurance for protection against unexpected weather conditions, but conventional insurance often only covers catastrophic damage, not reduced demand due to off-season weather.
An illustrative fact
- 20%: Portion of the U.S. economy directly affected by the weather.
Enter weather derivatives, offering protection through financial instruments to hedge against weather-related losses. Typically, the seller of a weather derivative bears disaster risks in return for a premium, profiting if no damages occur before contract expiration. In adverse weather events, they reimburse the buyer as agreed.
Weather Derivatives Background
In the late 1990s, weather quantification and indexing became tradeable commodities. The first such transaction happened in 1997 with a power contract by Aquila Energy. Since then, varying weather values comparable to stock indices, currencies, interest rates, and agricultural commodities have been traded.
Weather derivatives usually cover low-risk, high-probability weather events, while weather insurance typically protects against high-risk, low-probability events as defined in customized policies. Companies might benefit from purchasing both types of protection.
Related Terms: weather derivatives, catastrophe insurance, event insurance, homeowners insurance, property insurance.
References
- Vortex Insurance Agency. “Understanding Weather Insurance”.
- Allen Financial Insurance Group. “Weather Insurance — Event Insurance — Rain Insurance”.
- Insurance Information Institute. “Special event insurance”.
- Chicago Mercantile Exchange. “An Introduction to CME Weather Products”, Page 2.
- CME Group. “Introduction to Weather Derivatives”, Page 1.
