Frosts, droughts, floods and hot windy days can make farming a frustrating business at times. When everything under the control of management has been done to obtain the best result, but a weather event occurs that significantly reduces the expected crop income, an initial feeling of failure or anger can occur. Farmers are generally fairly resilient people though, who realise that the weather is out of their control and don’t dwell on it for too long, but look more for a positive from the situation.
Multi-peril crop insurance has been introduced into Australia recently, to provide farmers with a safety net for loss of income associated with certain weather events. While this is useful for some businesses, it can often be either difficult to obtain or at a cost that is potentially greater than the risk to be covered.
An interesting aspect of the technology revolution is that Big Data associated with weather is readily available in real time. This coupled with increased computing capacity, has allowed for efficient processing of the information. The outcome of this is that insurance companies can determine a risk profile for a certain weather event, at a certain location and calculate their cost to insure the event.
Many farming systems or locations have specific times during the production cycle, when the risk of a certain weather event that results in a significant loss of income occurring, is high. So why not just insure for that event and not for other events that are less likely to occur?
Weather Certificates are an insurance product that allows for specific weather events such as frost, flood, lack of rain, hot weather, or wet harvest to be insured against during the season. The single peril weather index certificate could be described as being very similar to a call option.
The certificate can be booked 20 days prior to the desired risk period and is automatically paid out 20 days after the risk period has ceased, if the event was triggered.
There is no need for claims or assessment, as it is based solely on the weather data (similar to a bet at the races!). Data from the Bureau of Meteorology is used to create a 5 x 5 km matrix in which individual locations are indexed against the data, to determine the trigger level for the event. These levels are specified by the farmer at the time of booking the certificate and will be reflected in the premium paid to cover the event.
The following example of a Frost Index Weather Certificate explains how they can be used:
Frost during October has become a consistent event for a certain farmer and loss of income from frost is a concern. Past experience and weather records show that any days below 00 C result in yield loss, so the cumulative days during October below 00 C would like to be hedged against. Therefore the trigger value for the event is set at -10 C.
The farmer considers that if the trigger value (ie: -10 C or less frost) occurs over say 1,000 ha of wheat they have in, it could cost up to $100,000 in lost income.
The insurer determines that the premium for the sum insured is $7,000, so the cost is $7/ha.
The farmer receives $10,000 up to a maximum of $100,000, for the cumulative degree days at or below the trigger of -10 C during October. Therefore three days at -10 C would result in a payment of $30,000, while two days at -10 C plus two days at -20 C, would result in a payment of $60,000 being received.
The crop type, weather event, risk period, event trigger plus sum insured can all be varied and this determines the premium paid.
Weather Certificates can be used as a tactical management tool during the growing season to obtain some control over the financial outcome from adverse weather events. Currently the only business providing Weather Certificates in Australia is Celsius Pro.