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A Study on Weather Insurance Pricing Based on Stochastic Temperature Modeling

  • Journal of Insurance and Finance
  • 2008, 19(2), pp.55-76
  • Publisher : Korea Insurance Research Institute
  • Research Area : Social Science > Business Management

Chang Soo Lee 1,  Hyuk-Sung Kwon 1,  하홍준 1

1숭실대학교

Accredited

ABSTRACT

Subject of this paper is weather risk which means financial risk that a business may be exposed regarding weather events such as high or low temperature, snow or rain more or less than expected, and strong wind. Since there is yet no established market for weather derivatives in Korea, weather insurance is the only available risk financing technique currently. However, despite the rather huge potential demand for such insurance products, the weather insurance market has not been so active so far, mainly due to the lack of feasible products which are reasonably priced from the insureds’viewpoints. This paper proposes a weather insurance pricing method which better reflects characteristics of weather variability in Korea. In order to do so, this paper suggests adoption of modified Cao-Wei model to represent variability of maximum daily temperature. This paper explains process for the application of suggested model and also attempts to compare the performance of this model and the index model which was used for the pricing of a weather insurance product introduced by property and casualty insurance companies in Korea. The empirical study performed on the temperature data of 10 inland cities including Seoul for last 10 years reveals that consistent over-pricing on the part of the index model.

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