In the latest in our series of interviews with figures from the risk transfer and insurance-linked securities (ILS) markets, Artemis spoke with Barney Schauble, Managing Partner at specialist catastrophe and weather risk asset manager Nephila Capital.
Barney has led much of the development and growth of Nephila Capital’s successful weather risk underwriting and investment activities, an area that he sees as set for growth both as a risk transfer product and an asset appropriate for ILS investors.
To start, could you please give some background to our readers about the weather risk activities at Nephila Capital, as they have often been overshadowed by catastrophe risks?
Nephila has managed a dedicated weather risk fund since 2005, and traded weather risk on an ad-hoc basis since 1999. In the early 2000s, prior to widespread investor adoption of catastrophe risk as an asset class, Nephila’s weather assets were a significant percentage of the overall platform. In fact the positive performance of the weather fund was welcomed by some investors as an offset to catastrophe losses during the busy hurricane season of 2005. The weather market remains much smaller than the catastrophe market – some small single digit percentage – and thus the strategy has also been a small portion of the platform in recent years. However, with the perspective of a firm that has been a rare consistent presence in the weather market over the past 15+ years, we believe that the weather market is poised for growth.
The weather risk management market looked set to become a global, exchange driven market 15 years ago, but today it’s increasingly a specialist market of large transactions. Why do you feel this is?
Weather risk transfer emerged as a hedging complement to energy supply- and demand-side risks. The earliest designers and adopters of the product worked on energy trading desks – at Enron, Koch, Aquila, and the like – and therefore the natural preference of those firms (and those people) was for products that could be traded on exchanges alongside traditional energy products. As it turns out, weather risk hedgers are similar to catastrophe risk hedgers: minimizing basis risk, customizing protection terms, and getting comfort with their counterparty are much more important to them than liquidity. We saw the same pattern developing as we had seen in cat (and see to this day) – buyers in all sectors of the economy really just want an over-the-counter risk transfer market where they can design weather protection to respond to their specific exposures.
Our weather strategy was based on that premise. Over time we have built a dedicated weather team who are focused on customized transactions. Many of these are the result of long-term partnerships and development of new products that could foster broader adoption of weather risk transfer. One example of this is the Proxy Revenue Swap product which we developed with Resurety and Allianz which provides a unique hedge for wind farm production; there has been some public coverage of those transactions (cite Artemis articles), and there are many more in the pipeline.
And for the investors reading, why do you (and Nephila) feel weather risks, which can often be more a case of volatility than severity, make a complementary asset to catastrophe risks?
Weather risk offers the same two basic attractions as catastrophe risk: a positive expected return relative to a quantifiable level of natural hazard risk, and zero correlation to financial markets. In addition, a weather portfolio of rain, temperature, snow, and wind volume risk has generally not been correlated to a catastrophe portfolio of earthquake and hurricane risk. In both cases, this is a risk that a business cannot manage itself operationally – it makes more sense for that risk to be held in a larger portfolio of cat or weather risks than for a protection buyer to hope for no catastrophe, or for high (or low) rainfall.
What have you (Nephila) been doing to grow the weather component of your business in recent years?
We have focused on identifying clear weather risks that impact multiple entities operating within a particular sector, and developing scalable weather risk transfer products internally and with market partners to address those risks. We also more than doubled the headcount of the Nephila weather team within the past 12 months to increase our capacity to encourage and digest growing interest in weather risk transfer solutions.
And what do you feel has been holding back weather risk transfer market growth?
One factor is continued lack of awareness amongst businesses and municipalities (and their shareholders / debtholders) that a market exists to manage their exposures to weather risk. Another factor is that, unlike catastrophe risks, regulators do not require entities to quantify and manage weather risks. This latter point appears to be evolving. For example, rating agencies have issued reports recently that highlight the risk of credit downgrades of water utilities if they don’t better manage the budget impact of weather events like drought.
A related but important factor is that like most re/insurance risk, there is a valuable role for intermediaries and MGA’s – as an advisor to a buyer which may not be familiar with these products. We have encouraged every broker with which we interact to consider the weather space as a huge opportunity to develop new products. Encouragingly, some firms are doing great work in the space – JLT, GCube, and Arthur J. Gallagher are examples of firms that are working hard to make their clients aware of these tools. However many others have not been very interested in the market: it is new and requires dedicated time and people, and they are wary of the fact that several major weather risk capacity providers are basically direct markets rather than broker markets. We believe that knowledgeable intermediaries – large or small, boutique or generalist – are going to be critical to unlock the true market potential and we are eager to support them.
With virtually every aspect of our economy exposed to weather variability in some manner, just how big do you think the weather risk transfer market could grow to be?
It is reasonable to expect that the demand for protection against weather risk is at least as large as that for catastrophe risk. The National Center of Atmospheric Research estimates that the US economy alone can vary up or down by $240 billion annually due to day-to-day (non-catastrophic) weather fluctuations. Many businesses and sectors are exposed to weather as a driver of revenues or costs, more frequently than they are impacted by catastrophe risk.
How difficult a job is it to blend catastrophe and weather risk into single investment funds or portfolios, while remaining mindful of investors return expectations and risk appetites?
We chose to manage weather as a distinct strategy, separate from catastrophe risk, in light of the fact that a weather portfolio has different risk/return characteristics and exposures. Investors can make their own choice as to allocate to either one, or both, as a function of their own risk/return preferences. To the extent that an investor allocates to both strategies, it requires systems that can reflect the joint distributions of potential outcomes – once those are built, it is not difficult.
With climate a huge talking point right now, do you see exponential growth ahead for the market in weather risk?
The increased focus on climate change and its potential impacts on local weather patterns is driving interest across all sectors of the global economy (including capital providers) to consider how they will identify and quantify weather risk. As entities become increasingly familiar with the financial consequences of weather risk it seems logical that they will consider weather risk transfer as a viable option to manage risk proactively.
Our thanks go to Barney Schauble for this insight into how Nephila Capital is developing its weather risk investments business and his views on how that market will grow in the future.
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