From the July-August 2008 issue of Treasury & Risk magazine

Respecting Mother Nature

The recent flooding in the Midwest and looming threat of hurricanes on the East Coast and in the Gulf of Mexico this summer highlight the need for companies to get a better handle on how to manage risks caused by changing weather patterns. In fact, 82% of senior finance executives and risk managers surveyed in a new study reported that they believe global climate change will require changes to their business models, according to CME Group and Storm Exchange. About 60% said the impact of weather-related risks on their businesses could be "significant" or "severe." The study included 205 senior-level finance professionals in mid-to-large size companies in such weather-sensitive industries as energy, retail, and construction.

But there are steps executives can take to manage weather risk, according to Paul Walsh, chief strategy officer at Storm Exchange, a New York City-based electronic weather risk exchange. The first one is understanding and measuring the impact that changes in weather can have on a company's lines of business and the bottom line to be able to prepare more effectively for whatever happens. That can mean anything from the effect of flooding on crops to the impact of a warmer-than-usual winter on sales of heavy coats.

The next step is developing ways to manage predictable risks. Weather forecasts made as long as two weeks ahead are accurate enough to use in forming practical decisions about how to mitigate against risks, according to Walsh. For example, an unseasonable 10-degree drop in temperature could be enough for a retailer to consider putting off a planned sale on winter clothing. "That kind of information goes right to the bottom line," says Walsh. "You have to manage the knowable." Storm Exchange was created in April, 2007, as a market for weather derivatives that can be used to hedge against the potential harm that severe heat, flooding or other weather events can do to financial results. The exchange says it expects contracts to reach $300 million this year, up from $20 million in 2007.

At the same time, despite the potential threat posed by flooding or other weather catastrophes, even companies in weather-sensitive industries haven't done much to protect against risks. About 50% of respondents to the survey reported that their companies are not well prepared to cope with risks posed by volatility in the weather. And only about 40% said they've tried to quantify their exposure to weather risk. "There is a best-practice gap across many companies in many industries," Walsh says.

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