A hotdog vendor's tale

Author: | Published: 1 Nov 2007

The advent and growth of weather derivatives instruments have given rise to the question of whether these hedging instruments are insurance products. Weather derivatives are financial instruments designed to hedge against weather variables such as rain, snow and temperature. They are based on an underlying reference point, which is generally a reference weather index. In exchange for an up-front, lump-sum premium received from the buyer on the date the transaction is entered into, the seller pays the buyer if the weather index increases beyond a threshold or strike level set in the contract. The payment is equal to the number of units by which the index deviates from the strike level times a notional amount per unit.

Couch on Insurance, a leading insurance treatise, defines insurance as "a contract by which one party (the insurer), for a consideration that usually is paid in money ... promises to make a certain...