As global warming increases the frequency of extreme climate events, the nature of weather risk is changing, as are perceptions of how it should be managed, says Martin Malinow, president of Sompo Global Weather, a division of Sompo International.
“What is becoming clear to us is that the expectation of ‘normal’ weather is evolving,” he says. “For the first 20 years, the [weather] market was focused on locking down annual variations in weather. [Now] our clients are increasingly looking to lock down that climate ‘drift’.”
The Earth’s average surface temperature has risen by 0.9 degrees celsius since the late 19th century, with most of this increase occurring during the last 35 years, according to US space agency Nasa. Furthermore, five of the warmest years on record have occurred since 2010.
As companies begin to factor climate change into their weather risk programmes, Malinow says Sompo is experiencing a “natural evolution of [its] business from one which is a weather risk management firm to a climate risk management one”. This means helping clients to manage long-term, and potentially dynamic, weather exposures.
Focusing on the four main verticals of energy, food, water and infrastructure, Sompo offers protection against an enormous variety of climate-related risks. This ranges from hedging food production for the agricultural industry – for example, by offering parametric insurance for longan fruit in northern Thailand – to managing construction risk on energy projects.
Sompo’s product set is clearly appreciated by the market, with the firm retaining its leading position among weather dealers in the 2019 Energy Risk Rankings.
Part of Sompo’s greatest success in 2018 was achieved in Australia, where the firm says demand rose from power utilities by 30% for temperature-linked products, triggered by several metrics, including power demand, wind speeds and power prices. Malinow says this is a good example of weather-derivative protection being driven by climate change and not just seasonality.
This product set is viewed as particularly useful in such a large country as Australia, which lacks a fully integrated power grid, as neither Western Australia nor the Northern Territories are connected to the country’s National Electricity Market, while prices still vary between six states that are plugged into the scheme.
“Despite being a smaller energy market by dint of its population, Australia is one of the largest markets for our products and one where we [saw] strong year-on-year… product evolution,” says Malinow, adding that some of these transactions were up to double their normal size.
Despite being a smaller energy market by dint of its population, Australia is one of the largest markets for our products and one where we [saw] strong year-on-year… product evolution
Martin Malinow, Sompo Global Weather
As it turned out, Australia did see some extreme temperatures in 2018, especially in South Australia, where Adelaide experienced a record high of 47.7 degrees Celsius at the end of January that year.
Malinow says several smaller power utilities could have been put out of business if they didn’t have this protection in place, given the price volatility that occurred last year. For example, quarterly volume-weighted average spot power prices in South Australia doubled to AS$150 (US104.80) per KWh between the final quarter of 2017 and the first three months of 2018, according to data from the Australian Energy Regulator.
“At Sompo, we developed products designed to trigger under conditions of extreme heat and we were happy to provide the financial backstop that our utility clients needed in extreme conditions like this,” he says.
With any derivatives or insurance-type product that pays out under certain conditions, the product provider is left with considerable risk to manage. Sompo’s wider risk management strategy includes having a diverse portfolio mix. Malinow says that while his firm has had to pay out on several of its Australian claims, this exposure was balanced by their other offerings such as high-river protection to Mississippi barges and crop insurance to farmers in Italy.
In 2017, Sompo introduced a platform called Weather Connect and last year it added more functionality, including allowing clients to transact directly via an application programming interface (API).
According to Malinow, this development is gaining traction. Sompo now has several clients in energy and agriculture that make all of their inputs into Weather Connect via an API connection, accounting for roughly 3-5% of the volumes on the platform.
Another success for the firm came in the European energy markets where unexpected weather patterns left utilities holding a mixture of warm-side protection during cold spells and were under-hedged during an unexpectedly cold spring. This threw some hedging programmes out of kilter.
Malinow says Sompo stepped in to help several utilities across Europe restructure their hedges in response.
“By working closely with our clients and understanding the issues they were facing throughout the season, and not just at the initial point of sale, we were able to facilitate value-added directional changes mid-season with positive outcomes,” he adds.