Weather Anomalies Determines Insurance Amount
UGM Faculty of Economics and Business with the Crawford School of Economics and Government, The Australian National University (ANU) have recently held a seminar with the topic Weather Index Insurance: Financial Innovations for Agricultural Risk Management and Development. The seminar held in the Bank Rakyat Indonesia (BRI) Auditorium, Level 3 of the Economics Master of Science/Doctor of Economic Sciences Building, has received support from MSi Studies Program/Economic Sciences Doctoral Program and the UGM’s Center for Economic and Public Policy Studies.
Two speakers at the seminar are Sommarat Chantarat, MPhill, MSc, PhD, who is ANU faculty staff and a graduate of Cambridge, Chicago, and Cornell University, and Muhammad Edhie Purnawan, SE, MA, PhD graduate of Monash and Melbourne University. The presenter is A. Tony Prasetiantono, MSc, PhD and the event is opened by Budi P. Resosudarmo, MSc, PhD representing ANU, and Elan Satriawan, Mec.Dev., MSc, Ph.D representing UGM’s Center for Study.
In addition to aim to establish cooperation between Indonesia and Australia, the seminar also aims to discuss the latest techniques development in the field of financial economics. According to Sommarat Chantarat, the world needs to create a season index number useful to determine the amount of weather-related insurance in the agricultural sector. This insurance is used for compensation if the sector is hit by disasters. "If there is no insurance, the costs incurred may be too expensive," said Sommarat.
Therefore, Chanrarat Sommarat said, a weather index is needed, which in turn can be used to determine the insurance costs that lead to compensation in case of weather anomalies. He explained there are stages of model derivation to design the insurance index, which begins with the identification of disadvantage that need to be insured, select the goal function measurably, and quantify the losses that will be insured and to make the optimal structure of contracts, followed by pricing and contract evaluation. The last one is a long-term impact assessment on the micro-level.
Edhie Purnawan in his presentation delivered that there are at least five keywords in financial innovation for weather insurance, namely (i) uncertainty, (ii) volatility, (iii) risks, (iv) modeling, and (v) probability. Uncertainty can lead to volatility which in turn increases the probability of established risk. Therefore, approach to the weather issue is required (which usually leads to losses) by modeling involving the probability factor.
Some volatility models such as that involved dummy variables, and the ARCH, GARCH, E-GARCH, TARCH models as well as some hybrids, according to Edhi Purnawan, need serious attention from the weather monitoring agency, for example from BMKG. Meanwhile, the Markovian Switching Modelling (MSM) is also very powerful for modeling the future of the weather, the calculation of the ergodik probability involved here. Variability of the weather in the earth will be able to be predicted by the MSM. "With the model involving volatility clustering and its probability, the risk can be calculated and forwarded to construct index numbers, for example by the method of Laspeyres, Paasche or a combination of both, Fisher's Ideal Index," said Edhie.
The combination of the suggested modeling Weather Index Insurance is expected to be calculated more precisely and accurately. Advantages of this modeling combination will produce a more direct calculation, avoid overfitting (exaggerate minor fluctuations), it is more realistic while having a strong predictive performance.