Weather the costs of winter

23 Nov 15

With budgets tight, councils have to protect themselves against cost hikes caused by severe weather. Could risk financing be a way to do this?

Weather forecasts for winter 2015/16 go from relatively mild but unsettled conditions to 36 days of snow. Extremes of weather can have substantial effects on local authority budgets; insurance may compensate for some costs due to severe weather, but these usually concern direct damage or injury.

Councils can call upon the Bellwin scheme for urgent financial assistance where “an emergency or disaster involving destruction of, or danger to, life or property occurs”. However, in the last prolonged period of exceptionally cold weather in 2009, only four councils received such payments.

There is no automatic entitlement to financial support under this scheme and ministers decide cases individually; Dumfries and Galloway Council had a Bellwin claim for £1.7m rejected in 2013 as most of its costs related to clearing and repairing roads and were deemed ineligible.

While a standard insurance policy would not cover increases in cost due to weather, it is possible to source protection via other risk financing solutions such as weather derivatives.

As a financial instrument, weather derivatives can be used as part of a risk management strategy to reduce risks associated with adverse conditions, such as losses resulting from deviations in temperature from the norm. For example, a ‘cooling degree day’ option may look at average temperatures over a defined period. Should temperatures drop below a figure agreed beforehand, a payment would be triggered to cover the policyholder’s increased costs.

Alternatively, protection could be offered against temperatures of, say, 10⁰C below the anticipated average for four consecutive days. If this occurred, a payment would be triggered to cover increased costs incurred due to the cold weather.

In short, a weather derivative is designed to take away the potential for unanticipated budget variances by paying a fixed cost to transfer that risk to the insurer.

Such products tend to be bespoke, with pricing very closely related to reviews of historical risk and based upon third-party weather data to assist in calculating indices. Costs that can be protected are not limited to the examples in the table and can be reviewed on a case-by-case basis.

Its inherent structural flexibility can make this form of insurance coverage particularly attractive to organisations that tend to be affected by volatile weather.

As an example, a premium is set to cover catastrophe risks only. If the insured does not claim for a set period, such as five years, the insurer may refund a substantial part of the premium – this could be up to 85% of it. The percentage of return will be based upon how high the attachment point of the weather variation is from the norm.

As budgets continue to shrink, councils will need to minimise the risk of cost spikes to best protect and preserve their budgets — innovative methods of risk transfer, like derivatives, should be explored alongside more traditional methods.

Covered or not?

Insurance is most likely to cover costs incurred by direct damage or injury caused by severe weather

Likely to be insured
Damage to property due to weather-related peril
Increase in negligence claims by people sustaining injuries because of bad weather
Increase in negligence claims because of damage to property caused by bad weather
Probably uninsured
Increased salt or other risk protection purchase
Increased use of heating
Increased costs of road repairs
Overtime payments for risk protection work
Reduction in revenue (eg from leisure facilities)
Increased costs of oil and other fuels due to surges in demand

 

  • Tim Devine
    Tim Devine

    Tim Devine is managing director of the insurance broker Arthur J Gallagher’s UK public sector and education team

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