Climate Change, Weather Insurance Design and Hedging Effectiveness

Ines Kapphan (), Pierluigi Calanca () and Annelie Holzkaemper ()
Additional contact information
Ines Kapphan: Agri-food & Agri-environmental Economics Group (AFEE), Institute for Environmental Decisions IED, ETH Zurich
Pierluigi Calanca: Forschungsanstalt Agroscope Reckenholz-Tänikon ART, Zurich, http://www.agroscope.admin.ch
Annelie Holzkaemper: Forschungsanstalt Agroscope Reckenholz-Tänikon ART, Zurich, http://www.agroscope.admin.ch

No 11-17, IED Working paper from IED Institute for Environmental Decisions, ETH Zurich

Abstract: The insurance industry has so far relied on historical data to develop and price weather insurance contracts. In light of climate change, we examine the effects of this practice in terms of the hedging effectiveness and profitability of insurance contracts. We use simulated crop and weather data for today’s and future climatic conditions to derive optimal weather insurance contracts. We assess the hedging effectiveness and profits of adjusted contracts that are designed with data that accounts for the changing distribution of weather and yields due to climate change. We find that, with climate change, the benefits from hedging with adjusted contracts almost triple and expected profits increase by about 240%. Furthermore, we investigate the effect on risk reduction (for the insured) and profits (for the insurer) from hedging future weather risks with non-adjusted contracts, which are based on historical weather and yield data. When offering non-adjusted insurance contracts, we find that insurers either face substantial losses, or generate profits that are significantly smaller than profits from offering adjusted insurance products. Non-adjusted insurance contracts that create profits in excess of the profits from adjusted contracts cause at the same time negative hedging benefits for the insured. We observe that non-adjusted contracts exist that create simultaneously positive profits and hedging benefits, however at a much larger uncertainty compared to the corresponding adjusted contracts.

Keywords: weather insurance design; climate change; non-stationarity; hedging effectiveness (search for similar items in EconPapers)
Pages: 50 pages
Date: 2011-09
New Economics Papers: this item is included in nep-agr, nep-env and nep-ias
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Citations: View citations in EconPapers (4)

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