Weather (Risk) Report
Maybe it’s confirmation bias but it seems to me like the human and economic impact of (severe) weather is increasing significantly.* I believe that this is in part driven by the inconvenient truth of climate change but also by economic growth, especially in the developing world as more people and wealth are exposed to the ravages of nature. And it is also certainly true that in a flat world, nature’s impact anywhere in the world is noticed and felt more deeply everywhere in the world (ie in the rich western democratic market economies.) Managing this risk, mitigating the impact will unavoidably grow in importance if we are to protect human life, raise living standards and pursue global economic growth in the years ahead. Climate risk is every bit as big and important (and inexorably tied to) financial, energy and commodity risk and yet the markets for the latter are currently orders of magnitude bigger, more liquid, more granular and more sophisticated than the market in weather. I don’t think this is ultimately sustainable – the opportunities (and benefits) of vibrant and developed markets to trade, hedge and invest in climate risks are too big.
Ok well, yes…so what? I mean what’s the big insight? It’s not as if climate or weather derivatives don’t already exist – and, notwithstanding recent strong growth – have failed to keep pace with the growth of even mature derivative and financial markets (interest rates, foreign exchange, credit…) And insurance and re-insurance companies have been in the business of managing and mitigating climate risks for centuries. And in any event, how will a market in typhoon risk save people and property in China?
As for the first point, all markets hit inflection points in their development; every trader knows the maxim ‘liquidity breeds liquidity’ and the factors leading to exponential growth in market size and sophistication are many and often interdependent – supply and demand, technology, infrastructure, market standards, legal and political. I won’t attempt here to develop the logic behind my thesis (perhaps a project for a rainy weekend?) but I believe that these factors are now coming together, starting to feed one another like the positive feedback loops of a tropical storm brewing over the warm waters of the Gulf of Mexico, and will drive strong and accelerating growth in climate markets and derivatives over the next decade.
As for the second point, well yes…but. But the insurance market (for climate risk) is inherently inefficient. Inherently illiquid. Inherently lumpy. Inherently homogeneous in terms of the tools on offer (essentially selling put options on loss of property or life.) Now there is nothing wrong with this – indeed it has provided and continues to provide a invaluable service and has been a key ingredient in maintaining economic growth and prosperity over the last century. But it is a tiny subset of what is possible. One only has to look at markets for managing interest rate or foreign exchange risk to see what could be. What will be. And the insurance companies will also benefit massively (at least the ones who adapt to a changing paradigm.) Think of how the business of commercial and investment banking has been transformed over the past 30 years.
As for the final question? Well no. Markets will not stop a typhoon from crashing into the China. It will not sweep a stricken fishing boat out of harm’s way. But I firmly believe in the power of markets to ultimately deploy resources, change behaviors and drive innovation that will mitigate the damage caused by that typhoon and help prevent putting the fishing boat in harm’s way in the first place. Again developing the arguments behind this conjecture is the domain of an essay or perhaps a book (another rainy weekend?), but if you believe in the power of markets, in the invisible hand, I think you probably understand my thesis.
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*I was inspired to write this post when I opened my weekly ‘Politics this week’ and ‘Business this week’ email alerts from The Economist and saw these three headlines:
Ethiopia appealed for international help as the death toll from recent flooding rose to 870. Officials are concerned that after a month of storms the country’s dams are holding so much water that it could spill on to surrounding towns and villages.
An aid organisation based in Seoul claimed that last month’s floods in North Korea left almost 55,000 people either dead or missing and 2.5m homeless. Good Friends said the North Korean government is trying to suppress news about the disaster for fear of stirring social unrest.
The death toll from the worst typhoon to hit China in 50 years reached at least 320. Wind speeds in the storm, which was centred on the south-eastern province of Fujian, hit 216kph (134mph).
In a much-watched court decision on disputed home-insurance claims arising from Hurricane Katrina, a federal judge in Mississippi ruled that a couple’s insurance policy did not provide for damages caused by flooding, but did for damages caused by wind. The distinction is significant for insurance firms, which do not usually pay out for flood damage in standard homeowners’ policies. The industry faces claims for billions of dollars that stem from flooding after Katrina and has already paid out nearly $18 billion in claims for wind damage.
Weather, weather everywhere, not any way to trade…(with apologies to Coleridge and Iron Maiden 
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