Malawi uses derivatives to hedge against bad weather

AllAfrica.com, via UN Regional Information Networks: Malawi, riding high on recent cereal surpluses, is hedging its bets against inclement weather disrupting its good fortune by using a financial derivative to offset agricultural risk. Unlike insurance, weather derivatives are financial contracts based on an underlying weather index; in the case of Malawi the index will use a model that estimates maize production based on rainfall data.

The thresholds underlying the rainfall index are based on a national maize yield assessment model used by the Malawi Meteorological Office since 1992 for forecasting maize production in the country. David Rohrbach, a senior economist at World Bank's Malawi office, told IRIN the goal was to reduce vulnerability to weather shocks in the context of strengthening food security.

"First, it is important to note that this is not a formal insurance policy, as might be transacted through an insurance company, with a payout when a problem is judged by the company to have occurred; this is a contract on the international weather derivatives market," he said, because the contract was based on rainfall levels.

…In June the World Bank agreed to create a new weather derivatives product, allowing Malawi to use the financial markets to offset risks from drought. The weather derivative market began in the US in 1997 and has rapidly grown into a multibillion-dollar industry used by investors ranging from agricultural industries to sporting events organisers.

Malawi introduced a fertiliser subsidy programme in the aftermath of the 2005 drought, which left nearly five million people in need of food aid, and has since become increasingly food secure…..

….In sum, if there is a significant drought in the country, the government will get a payout whose level is determined by the size of the premium paid and the severity of the drought….

Malawi's coat of arms, Wikimedia Commons