Retailers Exposed to the Elements: How Risk Solutions can Soften the Blow of Unseasonal Weather

The coldest March for 50 years has left the UK shivering, with many businesses in particular suffering significant decline in revenues as the unseasonal cold snap dictates consumer behaviours and people generally stay indoors.

While last year saw Britain basking in temperatures of over 20°C, this Easter weekend was the polar opposite, with the lowest temperatures recorded as -12.5°C in the Scottish Highlands. As well as traditional outdoor Easter activities such as Easter egg hunts, fêtes and parades abandoned as people stayed indoors and kept warm, businesses that would usually expect to start turning greater profits at the onset of spring have taken a serious knock.

Sales at garden centres and DIY stores are expected to be down by up to 50 per cent on the levels usually recorded over the bank holiday. Data providers have reported a 25 per cent decline in footfall on the weekend before Easter compared with the same weekend last year, which could indicate why UK DIY chain B&Q’s owner Kingfisher posted a 5.2 per cent loss in UK profits compared to 2012 and their speculation that poor weather is to blame for knocking upwards of £25m off annual revenues.

Innovative Risk Solutions Can Help

As discussed in our last blog, the weather risk market is growing and in excess of US$11billion worth of risks are covered every year. An increasing variety of index-based solutions are becoming available to help retailers and other businesses protect themselves against unpredictable weather patterns.

How it Works

Every solution is a bespoke financial contract, reflecting the desired risk management objectives of each situation. They are based around an index of any weather type such as rainfall, snowfall or temperature, or even just an ‘adverse day’ which could be, for example, any day that it snows. They can be accumulative, so measured over a period of time, and can also hedge against forecasts. Here’s how it works:

  • The optimum index needs to be designed to best reflect the risk concerned. Minimising basis risk – where there is a mismatch between the index and the actual loss – is the key consideration here.
  • A trigger point is agreed, so whenever the index breaches this trigger the contract will pay out, subject to its terms. Unlike a typical insurance policy, these products pay solely against the index measurement and do not adhere to the traditional concept of indemnity. For example, did we have the 10cms of snow we hedged against? Or the 3000mm of rain? Did it occur on the weekend/period as defined? Was winter colder than budgeted for? If yes, the solution responds.
  • The process to validate the claim is quick and simple: if the index has breached the trigger point and the Met Office (or other data provider) can confirm this, then a payment is due. Just how much money is paid out is established at the outset, for example, £x/mm of snow that settles over the trigger point.
  • Its simplicity enables speed and claims can be settled quickly; sometimes turnaround can be within a week.

Simple is Best

The uncomplicated nature of the product and fast settlement process ensures that it does not consume valuable management time, as can happen with many complex long-tail or business interruption claims. Businesses can therefore recover quicker from a poor season and can avoid lengthy disputes as there are no ambiguous exclusions to contest.

From the insurers’ perspective, the products are priced fairly on the probability of an index being breached; often based on decades of weather data to support this process, enabling them to be confident that their pricing is robust.

Footfall or Shortfall?

No matter whether a business is specialist or very diversified, an adverse season – such as the one we witnessed in 2012 and are currently wrapping up against now – can have had a highly detrimental impact on a retailer’s trading as their customers stay away. Weather risk solutions can provide valuable financial protection as our weather extremes become increasingly unpredictable.

About Claire Wilkinson

Claire is a Partner of Willis’ Global Solutions Consulting Group, and co-head of the Willis Weather Practice. Bas…
Categories: Retail | Tags: ,

2 Responses to Retailers Exposed to the Elements: How Risk Solutions can Soften the Blow of Unseasonal Weather

  1. Keith Riley says:

    An interesting blog, Claire. Are these solutions regarded as insurance products or derivatives, from a regulatory viewpoint? Can anybody purchase such a policy or must there be an insurable interest? Do the insurers have a need to protect their accumulations by buying reinsurance treaties?

    • Claire Wilkinson says:

      These structures can be purchased in either insurance or derivative form. If they are executed in insurance form, then the buyer must have be insurable interest. No insurable interest is required if the index based weather solution is executed in derivative form.

Leave a Reply

Your email address will not be published. Required fields are marked *