How can special risks be insured?
Bad weather, fluctuating exchange rates: risks that can arise from these are difficult to calculate. Is this now also synonymous with "uninsurable"? Not necessarily, says our expert in the following guest article.
Many companies are faced with risks that are considered "non-transferable". At times, some of these risks even threaten the very existence of the companies. But how do you deal with such risks? On the one hand, they should be reduced as far as possible with preventive and reactive measures from risk management and business continuity management. But very often, even after this, there is still a non-negligible risk for which a specific insurance solution can be examined.
Known and less known special risks
For some time now, there have been interesting solutions and constructs on the insurance and financial markets for such "uninsurable" risks that are not covered by classic insurance solutions. The best-known example is probably the hedging of exchange rate risks by means of the financial market. Less well known are the possibilities of risk transfer of weather risks. Here, the focus is not on classic damage caused by storms or floods, but on loss of earnings that are not preceded by physical damage. For example, if a mountain railroad is not allowed to transport passengers due to stormy weather conditions or an acute avalanche hazard, this leads to a loss of earnings.
When the weather goes crazy
Another example is Rhine shipping: Ships can only navigate all passages when the Rhine has enough water. The further the river level drops, the less the ships are allowed to load. If the water level even falls below the minimum level, transport must be stopped completely. Companies directly involved in transport are just as affected by such an event without physical damage as those companies that depend on the raw materials, supplies and goods transported in this way.
A similar risk exists for companies that operate a hydropower plant. In the event of a prolonged drought, the plant may no longer be able to produce enough energy and, in the worst case, the operating costs may exceed the revenue generated. This can be exacerbated if the electricity price has already been fixed in advance - which is often the case. The operator must supply electricity at a certain price even if the company's own power plant generates too little. This compulsory supply can only be covered by purchased electricity. The additional costs thus incurred can also be transferred. On the other hand, solar plants can only supply electricity in good weather. Transferring yield losses and additional costs can also be an attractive solution here to compensate for longer phases of insufficient electricity production.
Another interesting application of weather insurance is for organizers of outdoor events. If the weather is bad, it is to be expected that fewer visitors will come to an event. The financial damage that could result from bad weather can be countered preventively with a transfer.
Insurance for special risks
Alternative insurance solutions can cover all these risks so that they do not have to be accepted as "force majeure". Industries directly dependent on weather can also transfer weather risks. However, there is one prerequisite for risk transfer: measurability. Only if the trigger for the loss of revenue is measurable (e.g., amount of precipitation, water level) can an insurance product be structured. However, this allows the risk to be tailored to individual needs.
The interesting thing about all these solutions is that the costs of insurance are transparent, because the relationship between the damage and the trigger is precisely defined and tied to measurable parameters. This makes it possible, on the one hand, to predict the costs of the transfer relatively accurately and, on the other hand, to produce a precise cost-benefit calculation, since the expected value can be calculated on the basis of historical data. This helps in the decision-making process for risk transfer or ownership.
Another advantage is that there are hardly any obligations and reservations, since the individual determination of the trigger means that no exclusions are possible. So there are no nasty surprises when a loss occurs. Either the trigger was above the defined threshold and a payout is made or the threshold was not reached and the damage is within the range defined as acceptable.
Applicable in individual cases
It should be noted that such solutions are very individually designed and involve a certain amount of effort. Therefore, these constructs are only suitable for covering such risks that have been classified by a company as critical to its continued existence. Only in such cases can an alternative risk transfer create financial stability for the company.
Author:
Stefan Brändli studied geology in his Bachelor's degree and geophysics in his Master's degree at ETH Zurich. He then worked as a research assistant at ETH Zurich in the field of fluid dynamics. Since 2018, he has been working for Funk as a risk analyst in the Funk RiskLab and leads different Risk analyses (cyber risks, business interruption risks, NDBI risks, etc.) by means of simulation methods, among other things.
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