Weather derivatives' cover helps lower farm loan rates

Projects dependent on the vagaries of weather are now increasingly relying on a special insurance cover "" weather derivatives "" for credit enhancement.

"Banks and financial institutions (FIs) offer better interest rates to agriculture-based infrastructure projects where there is an assurance of cash flow due to insurance coverage," says ICICI Lombard head of risk and reinsurance Ritesh Kumar.

"Such risk covers put a floor on uncertainties, which are taken care of by the insurance company," said Kumar.

The first reinsurance-based weather derivative cover was designed by ICICI Lombard General Insurance Company for the Malana Power Company.

The policy has been priced at a premium of Rs 20-30 lakh for a coverage of Rs 10 crore. The 86 mw hydro-power project was initially financed by ICICI Bank and the risk then transferred to IDFC.

Under the terms, should power generation at Malana fall below 90 per cent, the insurance company will pay the first Rs 10 crore towards loss of profit to the power company.

This will help the power entity pay its dues to funding institutions among other expenses.

In the case of some hydro-power projects, lenders are looking for hydrology cover prior to financing these projects, said a senior public sector banker.

"To mitigate risks and get better lending rates, such covers are critical for standalone small entities," added Kumar.

In the event of a shortfall in rainfall or snow melt, which affects the quantity of power generated, the insurance company will pay for the loss of profit, said India Insure Risk Management Services managing director V Ramakrishna.

This broking arm was instrumental in concluding the first reinsurance-driven hydrology cover in the country.

ICICI Lombard is near to finalising a rainfall risk cover in Andhra Pradesh and a cover against pesticide attack.

From the lender's perspective, anything that helps reduce risks acts as a credit enhancement, and thereby puts a floor on the extent of uncertainties, said Kumar.

Citing the poor experience with crop insurance cover with losses of 400 per cent (that is for every rupee paid, the loss is four times as much), the use of weather derivatives will help bring down these losses," said state insurance officials.

The Wind Energy Producers Association of India has shown interest to purchase such risk products whereby the insurance company will pay loss of revenue/ profit in the likelihood of the wind speed not being adequate to generate power.

"There have been a lot of enquiries from wind and hydro power producers for weather derivatives, said The New India Assurance Company manager R Raghavan (chartered insurer, UK).

This state insurer is in dialogue with the Wind Energy Producers Association to offer wind cover.

The key impediments in offering this cover is the unaviability of sufficient data, which has prohibited many covers to be reinsured.

Insurance companies require at least 10 year data outlining the actual rainfall/snowfall/windspeed in order to structure a proper product.