Index insurance: Capturing knowledge for improved climate risk management and poverty reduction

Hellmuth, Molly; Bhojwani, H; Osgood, D; Hansen, J; Moorhead, A

doi:10.1088/1755-1307/6/2/422004

Cited by 4 publications

(6 citation statements)

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“…Identifying an index that involves a transparent, accessible, and reliable metric, particularly one that would be difficult for the insurer or insured to manipulate (i.e., reducing moral hazard concerns) while also correlating well with financial damages (i.e., low basis risk) is fundamental to developing effective risk management instruments. When low basis risk is achieved, indexed contracts have some distinct advantages over more traditional insurance, including lower transaction and administrative costs (e.g., no adjustors) and fewer concerns over moral hazard or fraud, all of which can translate into lower contract prices and therefore less expensive risk mitigation [ Hellmuth et al ., ; Skees et al ., ].…”

Section: Introductionmentioning

confidence: 98%

“…This research develops and evaluates the performance of an instrument designed to manage the financial risk of low water levels to shipping firms in the Great Lakes. Weather‐related instruments, such as index insurance, have been explored within the context of agriculture [ Chantarat et al ., ; Fuchs and Wolff , ; Hellmuth et al ., ; Kellner and Musshoff , ; Khalil et al ., ; Lou et al ., ], and hydropower [ Foster et al ., ; Kern et al ., ] where financial losses can be linked to water scarcity. Further investigations involve the use of index insurance to compensate for the lower revenues [ Zeff and Characklis , ] or higher costs [ Brown and Carriquiry , ] experienced by water utilities during drought.…”

Section: Introductionmentioning

confidence: 99%

“…Typical property/casualty insurance insures directly against specified damages or “covered losses.” Index contracts, on the other hand, define a metric, or index (e.g., cumulative rainfall) with payments triggered when the index falls below (or rises above) a predefined threshold [ Breustedt et al ., ; Brockett et al ., ; Hellmuth et al ., ; Skees , ]. In order for the contract to be effective, the index must be strongly correlated with financial losses.…”

Section: Introductionmentioning

confidence: 99%

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Hedging the financial risk from water scarcity for Great Lakes shipping

Meyer

Characklis

Brown

et al. 2016

Water Resources Research

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Low water levels in the Great Lakes have recently had significant financial impacts on the region's commercial shipping, which transports hundreds of millions of dollars' worth of bulk goods each year. Cargo capacity is a function of a ship's draft, the distance between water level and the ship's bottom, and lower water levels force ships to reduce cargo loads to prevent running aground in shallow harbors and locks. Financial risk transfer instruments, such as index-based insurance contracts, may provide an adaptable method for managing these financial risks. In this work, a relationship between water levels and shipping revenues is developed and used in an actuarial analysis of the frequency and magnitude of revenue losses. This analysis is used to develop a standardized suite of binary financial contracts, which are indexed to water levels and priced according to predefined thresholds. These contracts are then combined to form hedging portfolios with different objectives for the shippers. Results suggest that binary contracts could substantially reduce the risk of financial losses during low lake level periods and at a relatively low cost of only one to three percent of total revenues, depending on coverage level.

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Section: Introductionmentioning

confidence: 98%

Section: Introductionmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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Hedging the financial risk from water scarcity for Great Lakes shipping

Meyer

Characklis

Brown

et al. 2016

Water Resources Research

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“…The advantages of WII are significant. As weather index data is publicly available, contracts are more transparent and less susceptible to moral hazard (Hellmuth et al , 2009). The trigger condition of WII is easy to justify; hence, there is less transaction cost and the payout of indemnity can be conducted faster, which is attractive for both reinsurance and farmers (Rao, 2011).…”

Section: Introductionmentioning

confidence: 99%

Double trigger agricultural insurance products with weather index and yield index

Xiao

Yao

2018

CAER

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Purpose Agricultural weather index insurance (WII) has been introduced in pilot or experimental form in many countries. However, the effective demand for WII is often limited by the impact of the basis risk. Thus, the purpose of this paper is to propose a new type of double trigger product, named “supplement” type, to reduce basis risk and improve the performance of the standalone WII. Design/methodology/approach Two measures of performance are introduced by the certainty equivalent income of expected utility theory. Through the Monte Carlo experiments and empirical study, this paper compares the performance of three types of double trigger products. Findings The findings indicate that the supplement type can significantly improve the performance of the single weather index product. First, it covers the downside basis risk and the catastrophic basis risk when the standalone WII fails to do so, especially in case of extreme losses. Second, it is superior when the correlation between the weather index and the yield index is not so strong, and can further enhance the performance of insurance even when the weather index and the yield index are highly correlated, for which the standalone WII could perform well. Originality/value The supplement type double trigger product proposed in this paper as an enhancement version finds a more preferable way to improve the standalone WII with relative lower complexity.

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“…Financial instruments are commonly used to hedge uncertainties in electricity prices, fuel costs, and electricity demand (e.g., heating/cooling degree contracts) within the energy sector, but relatively few tools exist to specifically hedge against the financial impacts of water scarcity. Index insurance contracts, which are designed to pay‐off when some measurable quantity (e.g., precipitation) at a defined location crosses a specified threshold, have been investigated and applied in agriculture [ Chantarat et al ., ; Fuchs and Wolff , ; Hellmuth et al ., ; Kellner and Musshoff , ; Khalil et al ., ; Lou et al ., ]. Some investigation of the potential for more advanced streamflow‐based index contracts to be used by water utilities has also been undertaken [ Brown and Carriquiry , ; Zeff and Characklis , ; Zeff et al ., ].…”

Section: Introductionmentioning

confidence: 99%

Evaluating financial risk management strategies under climate change for hydropower producers on the Great Lakes

Meyer

Characklis

Brown

2017

Water Resources Research

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Hydropower on the Great Lakes makes up a substantial fraction of regional electricity generation capacity. Hydropower producers on the Niagara River (flowing between lakes Erie and Ontario) operate as run‐of‐river, and changing lake levels alter interlake flows reducing both generation and revenues. Index‐based insurance contracts, wherein contract payouts are linked to lake levels, offer a tool for mitigating this risk. As a potentially useful tool, pricing of financial insurance is typically based on historical behavior of the index. However, uncertainty with respect to the impacts of climate change on lake level behavior and how this might translate to increased (or decreased) risk for those selling or buying the insurance remains unexplored. Portfolios of binary index‐insurance contracts are developed for hydropower producers on the Niagara River, and their performance is evaluated under a range of climate scenarios. Climate Informed Decision Analysis is used to inform the sensitivity of these portfolios to potential shifts in long‐term, climatological variations in water level behavior. Under historical conditions, hydropower producers can use portfolios costing 0.5% of mean revenues to increase their minimum revenue threshold by approximately 18%. However, a one standard deviation decrease in the 50 year mean water level potentially doubles the frequency with which these portfolios would underperform from the perspective of a potential insurer. Trade‐offs between portfolio cost and the frequency of underperformance are investigated over a range of climate futures.

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Index insurance: Capturing knowledge for improved climate risk management and poverty reduction

Cited by 4 publications

References 0 publications

Hedging the financial risk from water scarcity for Great Lakes shipping

Hedging the financial risk from water scarcity for Great Lakes shipping

Double trigger agricultural insurance products with weather index and yield index

Evaluating financial risk management strategies under climate change for hydropower producers on the Great Lakes

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