Weather derivatives are the instrument for reducing financial risk in companies that have their profit and cash flow correlated to climate variables.

The product provides hedge against high probability events. Weather derivatives are based on an underlying that is not negotiable as opposed to the conventional financial derivatives.

The use of weather derivatives implies certain advantages against conventional insurance contracts:

  • They are linked to the weather station register, eliminating the need for loss proof or expert reports when the protection-buyer receives the payoff.
  • If the conditions for the payment occur, it is realized automatically in a few days.
  • The price (premium) is normally lower than with traditional insurance.
  • The operation involves far less time and complexity to be processed and closed.
  • Some structured products (collar or swap) without an initial premium can be formalized.

11/29/2013 1:24am

In practice the process of assessing overall risk can be difficult, and balancing resources used to mitigate between risks with a high probability of occurrence but lower loss versus a risk with high loss but lower probability of occurrence can often be mishandled.

12/07/2013 3:17am

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