Pricing of temperature index insurance

Che Mohd Imran Che Taib^a, b, , , 

Fred Espen Benth^a, , 

• ^a Center of Mathematics for Applications, University of Oslo, PO Box 1053 Blindern, N-0316 Oslo, Norway
• ^b Faculty of Science and Technology, University Malaysia Terengganu, 21030 Kuala Terengganu, Terengganu, Malaysia
• 
  

Abstract

The aim of this paper is to study pricing of weather insurance contracts based on temperature indices. Three different pricing methods are analysed: the classical burn approach, index modelling and temperature modelling. We take the data from Malaysia as our empirical case. Our results show that there is a significant difference between the burn and index pricing approaches on one hand, and the temperature modelling method on the other. The latter approach is pricing the insurance contract using a seasonal autoregressive time series model for daily temperature variations, and thus provides a precise probabilistic model for the fine structure of temperature evolution. We complement our pricing analysis by an investigation of the profit/loss distribution from the contract, in the perspective of both the insured and the insurer.

Click to read the full paper