Swiss Re Corporate Solutions has completed the issuance of the first weather-indexed parametric insurance policy for a hydroelectric power company in Brazil, helping the company to mitigate its risks associated with Brazil’s severe drought of recent years.
The insurance arm of global reinsurance firm Swiss Re has helped a Brazilian hydroelectric power generation company to offset the impact of extreme weather events on its revenues.
Brazil is the world’s third largest generator of hydro electricity, with it supplying almost 70% of the country’s energy needs. However the country is still recovering from the worst drought it has suffered in 40 years and as a result hydropower generation has dramatically fallen due to a lack of water in major reservoirs.
As a result of the ongoing impact of drought in the country, Brazilian energy prices have soared and large energy buyers have suffered severe losses, which makes securing price stability by transferring the risks associated with extreme weather attractive to operators there.
Swiss Re Corporate Solutions said that it is the first insurance or reinsurance company in Brazil to issue a weather-indexed parametric policy, which is designed to offer relief in the event of a similar drought. This parametric risk transfer solution enables energy providers to limit their exposure to extreme weather events, such as a lack of rainfall or flooding.
Rodrigo Violaro, the director responsible for weather-index products in Brazil at Swiss Re Corporate Solutions, explained “The severe drought in 2014 drastically reduced the water flow in our main rivers, and Brazilian hydroelectric plants suffered electricity production losses as a result. To compensate for the production shortfall, thermoelectric plants had to be brought on line. As these plants are more expensive to operate, energy prices soared.”
Energy price volatility such as this can cause significant losses, as energy companies often contractually agree to supply at pre-agreed pricing. With prices set in advance sales on the energy spot markets can result in losses, meaning that hedging out the causes of such price volatility, such as weather risks, can help to smooth revenue expectations for energy companies.
Insurance that pays out based on weather indices or parametric triggers can therefore be calibrated to provide protection against the kind of drought conditions that Brazil has suffered, and its impact on hydro power providers.
Swiss Re Corporate Solutions parametric insurance solution in this example has an index trigger which is based on the Affluent Natural Energy (ANE) index, which measures the energy obtained from the natural flow from a river.
The ANE index is estimated daily by the National System Operator (NSO), which is an independent body that coordinates and controls electricity generation and transmission facilities in Brazil.
“If the ANE is below 90% of the long-term average, Swiss Re Corporate Solutions pays financial compensation,” Violaro explained.
While this is the first time such a weather-index or parametric insurance or reinsurance solution has been used in Brazil, they are in use elsewhere in the world, particularly in energy and agriculture sectors.
These weather index and parametric trigger products are also offered by a number of the world’s insurance-linked securities (ILS) funds, who find weather risk a good complement to the catastrophe risks in their portfolios.
Luciano Calheiros, sales director of Swiss Re Corporate Solutions in Brazil, believes that use of such products will grow in Brazil, saying; “This type of product enables us to focus on the specific needs of companies in the energy and agribusiness sectors, which are fundamental for the Brazilian economy. We expect that here in Brazil the product will repeat the success it has enjoyed around the world and that it will become an important part of our portfolio.”
Swiss Re said that the volatility of weather and Brazil’s vulnerability to drought means that “the energy sector should actively look for risk transfer solutions that enable it to adapt to the consequences of extreme weather events and climate change in general.”