Parametric wind speed protection for a utility company
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Background: A state-owned utility in Europe was partly privatized, and decided to develop financial risk management and insurance buying capabilities. Wind storms represent a significant risk to the firm’s power lines. Strong winds can inflict direct damage to the grid lines, but they can also uproot or break trees which then fall on the lines.
Protection buyer objectives: The buyer was looking for efficient protection of its widespread supra-regional low-voltage distribution grid. This type of power line exposure was largely uninsurable via traditional insurance solutions. Additionally, one of the utility’s aims was to avoid ambiguity in a potential claims processing due to lack of clarity around expenses for rebuilding and for upgrading the grid.
Risk-transfer solution: The utility purchased a multi-year parametric cover based on wind speed, for which a third-party modelling firm developed a customized index. The index was designed to closely match the regional distribution of winds with the utility’s assets, thus reducing basis risk. The cover was issued as a private placement in derivative form.
Benefits: The parametric structure covers the utility’s low voltage distribution network. Unlike a pure indemnity cover targeted at the reconstruction of damaged goods, a parametric solution can be purchased that might even pay in excess of the pure replacement costs of rebuilding. The excess can be used to rebuild to a higher quality standard after a loss, contributing to the goal of gradually upgrading the grid.
In our newest sigma 05/2017 "Commercial Insurance: innovating to expand the scope of insurability" you can read more examples of innovative insurance solutions we have developed to protect our clients from earnings and cash flow risks. Click here to read the sigma (multiple language versions available).
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