Weather risk within the UK food and drink sector

The global climate is increasingly volatile and unpredictable, as evidenced by the prevalence of unusual and unseasonable weather we have witnessed in recent years. The food and drink industry is at the heart of this changing landscape. Following our 2019 research, uncertainty about the future has remained a concern for our clients. One major area of uncertainty relates to the changing climate and the financial impact of adverse weather.

• Commodity cost concerns.
• Weather volatility disrupting demand.
• Failure of supply from key suppliers.
• Availability of agricultural produce.
• Climate change.
• Crop failure.

The UK is experiencing more frequent ‘extreme’ weather events, highlighting the vulnerability of the food and drink sector to climate shocks. UK supermarkets lost £22m in sales following the freezing ‘Beast from the East’ episode in 2018.¹ Heatwaves in various locations across the globe in 2018 and 2019 caused widespread droughts, affecting both crops and livestock, disrupting global supply-chains and resulting in increased food prices. In the UK, February 2020 was the wettest on record with severe storms, Dennis and Ciara, contributing to significant flooding of farmland across the country. The changing weather has a dynamic impact on consumer behaviour and appetite, unavoidably impacting food and drink retail. Perhaps more important is the impact weather has on companies’ ability to supply produce. After all, the weather is inexplicably linked to agriculture, commodity prices and the food chain: from the soil all the way to the supermarket.

Traditional insurance offers limited protection for such weather-related downturns.

How can Parametric Solutions help?

Specialised markets in Alternative Risk Transfer can help transfer weather risk through parametric solutions. We combine expertise in the agriculture and weather-index markets to design bespoke solutions for our clients whose financial performance is impacted by the weather.

Parametric solutions can be designed to cover low crop yields or lack of sales due to adverse weather. We use data and analytics to tailor-make weather-index solutions for our clients. The index is based on data collected at weather stations or derived from satellites, hence correlation between revenue and the underlying weather component (rain, snow, temperature) is crucial.

The policy triggers if the parameter falls below a pre-agreed threshold. Payments are made purely on the value of the index rather than the actual loss suffered. Hedging weather risk should be a natural and normal part of a company’s business strategy, neutralising avoidable volatility.

1. 01

   Weather-index insurance

   This policy responds to movements in a weather denominated index. The index, likely to be a measurement of temperature or rainfall, acts as a proxy for crop performance.

   Characterised by their flexibility, these solutions are highly bespoke to the requirements and profile of the insured and their crop risk.

   As claims are not driven by actual losses, a poorly designed index may result in basis risk (difference between the buyer’s financial loss and the policy pay-out).

2. 02

   Yield-index insurance

   The policy references an index which may reflect the average yield of a region or the specific yield of the insured, for the harvest in question.

   Losses are calculated on the index at the end of the season, with units below the trigger being compensated at a fixed value: the more units of loss= the greater the pay-out.

   Characterised by its simplicity and its prompt loss calculation but it has the potential for ‘basis risk’ if the grower’s crop is not well represented by the reference yield.

3. 03

   Weather and transaction-number index insurance

   This index, calls upon a measurement of temperature or rainfall to qualify the ‘extreme’ weather, it then settles off clients’ transaction-numbers.

   Provides revenue protection during peak seasonal sale cycle.

   If the weather trigger is breached, then the policy pays according to the deficit in transaction-numbers for the impacted quarter.

   Fixed payment per missing transaction reflects the profit per transaction as set by the client.

4. 04

   Double-trigger insurance

   This policy combines a weather- index trigger with an indemnity pay-out.

   If the value of the weather-index meets the agreed trigger, losses are paid based on actual crop loss.

   Characterised as ‘bespoke’ with pay-outs that accurately match actual loss, they can require a great deal of design to ensure appropriateness.

   Key commodity price hedging can be offered.

Our Alternative Risk Transfer Solutions team is a a global team that focuses exclusively on alternative risks and innovative methods of transfer. The team is a leading broker of parametric and weather-index solutions with experience and expertise in structuring, executing and syndicating parametric solutions for buyers across many industry sectors and geographies.

Footnote

¹ https://www.theguardian.com/business/2018/apr/04/beast-from-the-east-cost-uk-supermarkets-22m