MRTL on weather derivatives: a quarter century old, but coming into their own

Reinsurers are playing a key role as the weather derivatives market expands, according to Munich Re Trading LLC (MRTL) president and CEO Bill MacLauchlan.

MRTL is the division of Munich Re focused on weather and commodity products, including derivatives, index and parametric risk transfer.

“Much of [the] weather market risk that sits on a balance sheet – that's not very fungible, and is held in a risk warehousing type of way – that's primarily driven by reinsurers,” MacLauchlan told The Insurer TV.

While weather derivatives are a small section of the entire weather risk transfer market, and a niche industry compared to other traded markets, they are becoming more popular, MacLauchlan confirmed.

“What we see is that the tight energy supply situation globally is making temperature in particular more relevant for energy commodity markets. And that translates into folks wanting to use those products to manage their volumetric risk, which is tied to temperature that drives demand.”

Some weather risk is transferred as parametric insurance, and some goes through an exchange, with the primary entity being the Chicago Mercantile Exchange (CME.)

Last year CME reported that the average number of unsettled contracts in weather futures and options was significantly higher than the previous year. Also in 2023, the CME listed futures in six additional cities, including Paris, Philadelphia and Boston, citing an “increasingly robust” market.

With hastening climate change ramping up the risk and cost of natural disasters, weather has become a more salient issue, according to MacLauchlan. He said weather derivative products can help firms reduce uncertainty and have become an increasingly important part of solving risk management issues.

The CEO described how weather derivatives play out between reinsurers like MRTL and clients.

“The prototypical transaction will be between an energy company that's not particularly diversified, that doesn't have the strongest balance sheet, that has a concentration of weather risk, moving weather risk from their balance sheet to a very healthy, diversified, large, highly rated reinsurer.”

Reinsurers will then warehouse that weather risk, and carry it on behalf of the energy company.

Munich Re estimates that more than two-thirds of the global economy is “directly or indirectly dependent” on meteorological conditions. As awareness of and fallout from global climate uncertainty grows, so too could weather risk transfer products, which could act as a hedge against that uncertainty. If expansion were to accelerate, MacLauchlan said there would be ample capacity to fill those needs.

“If tomorrow, the light switch changed and everybody wanted [a weather derivative] product, obviously, you know, that would be a bit of a jolt. But… as you saw with any of the other more catastrophic-type events, capacity can be found quite quickly when needed.”

MacLauchlan added that finding capacity would be a good problem to have.

“It's more likely that you have slow growth, continued awareness, and the capacity will come along with that.”

Watch this 14-minute video to learn more about:

  • Why reinsurers are key to the growth of the weather derivatives market
  • What’s driving increased interest in weather derivatives
  • What role derivatives can play in overall risk transfer
  • Why weather derivatives could become even more popular in 2024