Nephila Builds a Portfolio of Weather Risk Transfer Contracts

Abstract

The weather team at Nephila Capital Ltd. (Nephila) was in the midst of the weather market's busy winter renewal period. The list of weather risk transfer contracts that needed to be analyzed and priced seemed to be growing by the minute, and one team member is devising a plan to price each deal on its own merits of risk/reward. The counterparty's bid would reflect the willingness of the contracting party to pay for a weather hedge, and none would pay more than the bid amount. Nephila wanted to meet the needs of each counterparty, but only if Nephila earned a requisite return on capital. If the bid amount were not high enough to be attractive to Nephila, the team would need to convey that news to the counterparties. Did these new deal opportunities offer something more to Nephila beyond their individual numbers?

Excerpt

UVA-QA-0844

Rev. Apr. 28, 2016

Nephila Builds a Portfolio of Weather Risk Transfer Contracts

On a sunny fall day in Bermuda, Matthew Coleman sat at his desk on the trading floor of Nephila Capital Ltd. Nephila's weather team was in the midst of the weather market's busy winter renewal period. The list of weather risk transfer (WRT) contracts that needed to be analyzed and priced seemed to be growing by the minute. After Coleman surveyed the latest group of deals, he began devising a plan to price each deal on its own merits of risk/reward. Given the counterparties' bids, which reflected the willingness of the contracting party to pay for a weather hedge, he pondered which of the deals would be attractive to Nephila on a stand-alone basis. Nephila wanted to meet the needs of each counterparty, but only if Nephila earned a requisite return on capital (ROC). What should be done if a deal did not produce a satisfactory return? It was clear that the counterparties would not pay more than the bid amount. And if that amount were not high enough to be attractive to Nephila, Coleman would need to convey that news to the counterparties. Did these new deal opportunities offer something more to Nephila beyond their individual numbers?

Nephila Capital Ltd.

Nephila, founded in 1997, was the largest investment manager that was dedicated solely to underwriting global weather and natural catastrophe (NatCat) risk. At the beginning of 2015, Nephila's assets under management (AUM) were approximately $ 9.5billion. The vast majority of Nephila's capital came from institutional investors such as pension plans and university endowments that sought exposure to nontraditional, diversifying asset classes. These investors were drawn to weather and NatCat risk because the occurrence (or absence) of warm, wet, windy, or sunny weather and extreme events such as hurricanes and earthquakes was uncorrelated to the broader financial markets where they held most of their investments.

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Keywords: weather risk transfer market, weather derivative, weather risk transfer contract, hedge, return on capital, ROC, portfolio diversity, derivatives, Enron weather derivatives