Weather derivatives are financial instruments that can be used by organizations or individuals as part of a risk management strategy to reduce risk associated with adverse or unexpected weather conditions. Weather derivatives are index-based instruments that usually use observed weather data at a weather station to create an index on which a payout can be based. This index could be total rainfall over a relevant period—which may be of relevance for a hydro-generation business—or the number where the minimum temperature falls below zero which might be relevant for a farmer protecting against frost damage.
As is the case with parametric weather insurance, there is no proof of loss provision. Unlike "indemnity" insurance-based cover, there is no need to demonstrate that a loss has been suffered, however an indemnity insurance policy for weather is a rarely utilized instrument. Settlement is objective, based on the final value of the chosen weather index over the chosen period. If a payout is due, it is usually made in a matter of a few days with the settlement period being defined in the contract.
See Exotic derivatives.
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