Weather derivatives: call them insurance: defrocking weather derivatives and classifying them as what they are, insurance products, can only serve to benefit the public, claims the National Association of Insurance Commissioners.Editor's note Editor's Note (foaled in 1993 in Kentucky) is an American thoroughbred Stallion racehorse. He was sired by 1992 U.S. Champion 2 YO Colt Forty Niner, who in turn was a son of Champion sire Mr. Prospector and out of the mare, Beware Of The Cat.
Trained by D. : The following is a summary of a draft white paper titled Weather Financial Instruments: Insurance or Capital Markets Products? published by NAIC NAIC
See National Association of Investors Corporation (NAIC). .
Virtually every business is subject to some fiscal impact by the weather, which can cause earnings to fluctuate from year to year depending on weather conditions. A prudent business will account for its weather risks and take appropriate risk management measures to guard against financial loss by using weather insurance.
Weather insurance was initially sold to the outdoor entertainment industry as rain insurance for sporting events, musicals, county fairs, outdoor charity events and film screenings. Over time, contracts involving both temperature and snowfall have been added to simple "rainy day" contracts in response to market demands and need for businesses to protect themselves from the financial consequences of inclement in·clem·ent
1. Stormy: inclement weather.
2. Showing no clemency; unmerciful.
Now, one of the largest buyers of weather insurance is the energy industry. Taking advantage of the possibilities that deregulation Deregulation
The reduction or elimination of government power in a particular industry, usually enacted to create more competition within the industry.
Traditional areas that have been deregulated are the telephone and airline industries. offered, entities like Enron, Aquila and others decided it would be a good idea to offer financial instruments such as derivatives, weather hedges, and swaps to protect their earnings against unpredictable weather. Thus these entities embarked on a campaign to buy, sell and trade these risks among themselves and in the capital markets as "non-insurance" risk transfers. This ultimately resulted in the creation of a multibillion-dollar industry.
The energy trading business started rather innocently as their initial intent was for the energy provider to create a financial hedge against the consequences of change in demand for energy. Mild temperatures depress de·press
1. To lower in spirits; deject.
2. To cause to drop or sink; lower.
3. To press down.
4. To lessen the activity or force of something. the demand for natural gas or heating oil, while extremely cold temperatures cause demand to rise beyond their capacity to deliver the product, causing them to seek added supplies on the market. Either of these circumstances potentially cause financial loss to the business.
Generally, businesses that are involved in accepting risk transfers for a fee are known as insurers and the fee paid by the entity seeking to transfer its risk is know as premium.
Energy traders have gone to great lengths to train those providing the energy contracts to use terminology that distinguishes them from weather insurance products. Nevertheless, a weather insurance product and a weather derivative Weather Derivative
An instrument used by companies to hedge against the risk of weather-related losses. The investor who sells a weather derivative agrees to bear this risk for a premium. If nothing happens, the investor makes a profit. apply the same seven common elements. The policy specifies the named insured, the policy period, the coverage limits, the peril insured against, the premium, the weather reporting station and the trigger of coverage. Although sometimes carefully crafted to have different nomenclature nomenclature /no·men·cla·ture/ (no´men-kla?cher) a classified system of names, as of anatomical structures, organisms, etc.
binomial nomenclature , [there are] legitimate concerns about whether weather derivatives Weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. are truly capital markets products or are simply insurance products that are misclassified as such. Of further concern, there are several reinsurers that offer weather insurance products as a reinsurance The contract made between an insurance company and a third party to protect the insurance company from losses. The contract provides for the third party to pay for the loss sustained by the insurance company when the company makes a payment on the original contract. contract for energy providers. There are several regulatory issues and concerns in this area.
Classification of these "derivatives" as insurance would provide consumer protections that are associated with the regulation of insurance. Purchasers of the insurance contracts can expect that state regulators will be reviewing the contracts for compliance with state law. The rates and rating systems applied to the contracts would be subject to scrutiny to assure that the rates charged are not excessive, inadequate nor unfairly discriminatory dis·crim·i·na·to·ry
1. Marked by or showing prejudice; biased.
2. Making distinctions.
These weather financial instruments are and should be classified and regulated as insurance products for the benefit of the public. Energy traders need to limit their trades to the commodities that they market and leave the risk transfer of the financial consequences to those that are in that business; namely insurers.