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Impact Of Volatile Weather On Businesses’ Profits Is Increasing

Volatile weather activity is increasing around the world as evidenced by recent major events, such as typhoon Haiyan in the Philippines or flood Cleopatra in Sardinia. Yet, while extreme events may capture the headlines, minor fluctuations in expected weather can have big impacts on business performance across a wide range of industries.

In its new report ‘The Weather Business – How companies can protect against increasing weather volatility’, which focuses on the growing importance of weather risks for businesses, industrial insurer Allianz Global Corporate & Specialty SE (AGCS) highlights the economic impact of fluctuating weather conditions and how companies can protect themselves, using new approaches to ‘weather risk management’.

According to the report, the economic impact of increasing everyday weather volatility far exceeds the already huge sums annually associated with natural catastrophes. AGCS estimates that the impact of routine weather variation on the European Union’s economy could total as much as €406bn (£346 billion /$561bn) a year. As a comparison, during 2012, there were 905 natural catastrophes worldwide, 93% of which were weather-related disasters, costing US$170 billion[2]. And what’s more, the direct cost of weather volatility around the world is increasing significantly. According to Allianz, insurers have paid out US$70 billion globally for damages from extreme weather events every year for the last three years alone. Back in the 1980s, “only” US$15 billion a year was paid out for such claims.

In many countries, retail is one sector which is heavily exposed to poor weather, especially in the all-important pre-Christmas period when retail footfall traditionally increases significantly. Other sectors which can be badly affected include the agri-food industry, construction, distribution, energy, tourism and transport.

Protecting against the hidden costs of ‘normal’ weather

Despite these losses, many businesses are still failing to identify the link between climatic conditions and their own revenue streams. Yet, the weather does not even have to be extreme in order to have a negative impact on a company’s cash flow. Sometimes it is enough for it to be uncommon, unseasonal or merely unexpected to generate a decline in revenue.

In the past, many businesses did not know how to protect their profits from unfavorable weather conditions. However, there is now an increasing awareness and interest in weather risk management tools, as provided by AGCS subsidiary Allianz Risk Transfer (ART), which enable companies to hedge this risk, similar to the way they might do with interest rate movements and foreign currency exchange rates.

Weather risk management offers a new avenue for companies to create customized responses to the specific weather variables which can affect their business. Using independent weather data, these products are linked to actual fluctuations against pre-agreed weather indices which, when certain criteria are met, can trigger a payment. Crucially, unlike with traditional insurance products, no physical damage is required for a payment to be made to the affected policyholder. Measurable variables such as temperature, rainfall, sunshine, snowfall and wind form the basis for these risk indices, so a quick payment is triggered automatically when measurements prove certain pre-defined levels for the selected weather variable(s) have been reached.

“However ‘bad’ the weather is, it is no longer a good excuse for disappointing earnings,” explains Karsten Berlage, Global Head of Weather Risk Management at ART. “Stakeholders are increasingly aware of this. While companies cannot be expected to control the weather they are now expected to better control the risk of its financial impact. This can be achieved through weather risk management solutions.”

Availability and access to weather data have improved dramatically over the past decade, further strengthening the argument for strategic weather risk management and enabling protection to be structured even in remote locations around the globe.

Expanding solutions for a broad range of sectors

In the field of agriculture, weather risk management solutions are already protecting the crops of farmers across Africa from drought. Energy companies – both in the traditional and renewable sectors – are extensively using these solutions to protect themselves against unfavorable seasons and safeguard revenues. Meanwhile, wind farm operators seek protection against low or excessively strong wind to secure cash flow and underpin their financing.

Despite the growing importance of online trade, the retail industry is still highly exposed to weather volatility. Weather risk management solutions can protect retailers from a drop in earnings in the event of customers being unable to go shopping because of heavy rain and snow or changing their demand for seasonal products.

Weather risk products may even be used as marketing promotions. Car manufacturers may entice potential buyers of convertibles with a “sunshine guarantee”. Owners would be protected against a lack of sunny days if they are unable to have the roof down for a more than a pre-defined period.

A bright forecast

Weather risk management products are already widely used in the US, where they have become more readily accepted as a standard feature of companies’ overall risk management. In the UK, and elsewhere in Europe and other parts of the world, the product is still emerging, being used by a growing number of firms to deploy increasingly sophisticated solutions to their business challenges. Karsten Berlage anticipates “Weather will increasingly be viewed as a core risk to business performance. Therefore, demand for weather risk management solutions should grow significantly in the future with stakeholders able to reap the benefits of better cash flow stability, more accurate budget management, greater earnings consistency and higher risk-adjusted returns.”

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