This will be a shameless plug. However, just maybe an example will also show why I think insurance can be so interesting!
The first snow hit Lake Tahoe this week. That's good news. Why? Everyone begins to worry about winter. That's where my new company comes in, and why this is a shameless plug.
[Don't forget the disclaimer: I am not advising you on insurance or derivatives transactions.]
Most people I know will very soon cut a deal with their landscaper to plow their walks and driveway. Your landscaper charges you one of two ways. Either a fixed price for the whole season, or a variable price based on how much it snows.
With a fixed seasonal contract, if it snows very little, you feel ripped off, and your landscaper has a windfall for no work. If it snows too much, you have a windfall, if your landscaper actually clears your driveway for that tenth blizzard of the year. Only in a narrow band of snowfall do you both feel "okay".
The per event or per inch contract is just as bad. You have no idea how much you'll have to pay. Your landscaper (if he's like my kids) sleeps with his pajamas inside out with pennies on the windowsill all winter, hoping he can pay his mortgage.
In fact, the seasonal contract you bought amounts to buying insurance against snowfall from a guy whose primary systematic risk in his life depends on snowfall. By design, you have to overpay him for this. If you go with the variable cost, you have potentially massive budget uncertainty. (This is exactly like my past discussions about why you cannot hedge the ultimate financial disaster!)
"Massive" could be an exaggeration for you personally, but for plenty of businesses, it matters. Imagine you have a really big driveway--more like a parking lot. You must keep it clear at all times. You get the idea.
You wouldn't buy car insurance from your landscaper, so why do you buy weather derivatives from him?
So, what do you do? You need a third party. Ideally, this third party understands snowfall risks, but doesn't really care much. They take lots of different risks. Your bit of snow matters little. That's where insurers come into the picture. As much as people love to hate insurance companies, they're in business to bear risk the rest of us cannot take.
