Weather risk solutions

In 2000, we formed Element Re as the ideal platform to help the weather risk market evolve to the next step � one where solutions can be packaged to suit the individual needs of each client. Combining Element Re Capital Products� experience and XL�s insurance expertise gives us the market awareness, product knowledge, financial strength, global reach and capacity to meet growing demand for risk solutions. XL Capital and its operating subsidiaries have become leading providers of insurance, reinsurance, and financial products and services on a global basis. With its issues traded publicly on the NYSE under the symbol �XL� and its XL insurance subsidiary rated A+ (superior) by A M Best and AA by Standard & Poor�s, XL reported consolidated assets of $28 billion and consolidated shareholders� equity of $5.4 billion as of December 31, 2001.

Why customised solutions?
Since weather risk exposures are unique and complex, customised solutions are a necessity. The Element Re team works closely with each of its clients in identifying and quantifying the specific weather risk affecting business operations. We then develop and execute customised solutions that meet the client�s desired financial goals. The availability of various risk management products, on a wide range of weather variables and geographic locations, allows us to create truly individual solutions.

A typical weather risk management programme involves defining key parameters such as:

• type of risk (generally based on a measurable index such as tempera- ture, rainfall, snowfall, humidity, wind, or streamflow);
• term (the duration of the contract);
• location (the locale of the weather reading, typically based on single/ multiple weather stations that are monitored by an independent agency affiliated with the World Meteorological Organization);
• notional (the dollar value of payout per unit of weather), limit (the maximum financial amount of coverage), policy type (the structure delineating the conditions of payment) and;
• trigger (the weather index level above or below which coverage takes effect).

The cost of a weather risk solution is a function of several variables, including the specific type of coverage/structure, the estimated frequency of occurrence and the historical severity of loss.

Most activity in the market, up to the present time, has been in the form of temperature contracts. In the US market, temperature contracts are typically denominated in heating degree days (HDDs) or cooling degree days (CDDs). An HDD measures the relative coolness of a given location over a period of time. Specifically, an HDD is the greater of (a) zero or (b) 18 degrees Celsius minus the day�s average temperature (calculated as the average high and low temperatures from midnight to midnight); the HDDs for an entire period are computed by summing up each day�s HDDs.1 CDDs, which measure a location�s relative warmth, are computed by selecting the greater of (a) zero or (b) the day�s average temperature less 18 degrees Celsius.

While HDDs and CDDs are very common in the US market, other temperature-related structures are emerging. For instance, the critical day contract, which measures temperature on a single day (or group of days), and provides protection if the actual temperature is above or below a specified level, is becoming increasingly popular. The European temperature market is geared primarily towards use of peak or average temperatures, rather than HDDs or CDDs.2 Contracts based on rainfall or snowfall are generally measured in terms of inches or centimetres of precipitation, falling during a predefined time period at an approved weather station location. Likewise, wind protection is based on peak or average wind speeds recorded by an anemometer at a given location.

Benefits
By implementing weather risk management programmes based on the broad parameters described above, Element Re Capital Products can help companies protect weather-related revenues, reduce earnings volatility, more accurately forecast projected costs and more effectively control cost of capital. Ultimately, companies that proactively manage their weather risk reduce financial uncertainty and increase shareholder value.

The German and European markets
A prime example is Elektrizit�tswerk Dahlenburg AG, a German utility that worked with Element Re to complete its first European deal in May 2001. It was one of the first market transactions to protect a business against rainfall (instead of temperature, a much more common index for utilities). The deal was structured around rainfall because of its influence on Dahlenburg�s revenue � many of the utility�s customers are farmers who use electric power to pump water to their crops during periods of insufficient precipitation � as a result, during periods of excessive rain, Dahlenburg stands to lose significant revenue. The policy, which paid out in favour of Elektrizit�tswerk Dahlenburg later in the year, was an important part of the utility�s financial well-being.

The creative nature of the Dahlenburg deal is an indication of the health and potential of the German weather risk market. Another positive indicator is the involvement of Deutscher Wetterdienst (DW), the German weather agency, in the weather markets. DW provides access to historical climate data, a must for developing any worthwhile weather hedge. Access to data is one of the largest issues affecting the European weather market and Deutscher Wetterdienst is playing a leadership role, as it demonstrated when its officials attended and presented at the European Committee meeting of the Weather Risk Management Association (WRMA), which was held in Frankfurt in November 2001.

As for the rest of Europe, growth is healthy and promising. A number of new players have entered the market in recent months including banks and exchanges. Key new indexes are also being developed, such as London�s Liffe exchange, which began offering weather-related futures contracts at the end of December 2001. We�re also seeing more independent weather risk management providers getting involved in the European market, Element Re included, which is a signal of its long-term potential.

This optimism is borne out by WRMA�s survey of the international weather market, conducted in conjunction with Price waterhouseCoopers and released in June 2001. According to the survey, after North America, Europe has emerged as the second largest geographic market in the industry. The total notional value of the first contracts traded in Europe, in the winter of 1998, was only $320,000. But, by winter 2000 � the last season measured by the survey � the total value transacted was more than $49.1 million. And, in the time between the first trade and the last recorded by the survey, the European market has been responsible for trades with a total of more than $120 million. We expect to see even more significant growth documented this year. Results of the most recent market survey � including transactions for 2001�2002 � will be announced in June at the WRMA conference in Miami, Florida.

The development of the weather risk management industry around the world is encouraging. As each regional market develops, they begin to take on their own traits and characteristics, true marks of growth and maturity. Japan, Australia and South Korea are growing at a rapid pace in the Asia-Pacific region; the UK, Germany and Scandinavia, to name just a few, are doing the same in Europe; North America continues to expand and diversify and the developing nations of the Southern Hemisphere are also getting involved. And, as the market evolves, Element Re plans to expand and grow with it.

1. For instance, if the average daily temperature in a particular location is 44 degrees farenheit, the HDDs for that day amount to 21.
   
2. The new Liffe indexes are based on average daily temperatures applied to a monthly mean.
   
   

Element Re has written a comprehensive book about the weather
market and weather products. For a description and purchase
information, please search for weather risk management on
www.amazon.co.uk.

Contact: Element Re Capital Products Inc,
Tel: +1 203 356 3580
e-mail: ccollins@elementre.com
Website: www.elementre.com