Swiss Re has entered into a weather derivative contract with the International Development Association (IDA), an arm of the World Bank.

Under the terms of the contract, Swiss Re will pay out up to $5m in the event that Malawi’s farmers suffer from a drought-related shortfall in maize production. With this transaction, the IDA backs its first ever weather derivative contract with the Government of Malawi.

“The weather derivative contract with the World Bank is a prime example of an ex-ante disaster risk management strategy designed to mitigate the financial impact of drought for a country such as Malawi that is heavily dependant upon the income from its agricultural production,” said Juerg Trueb, Swiss Re’s Head of Environmental and Commodity Markets.

The World Bank, working together with the Government of Malawi, structured the contract as an option on a rainfall index. The index links rainfall and maize production, so that if precipitation falls below a certain level the index will reflect the value of the projected loss in maize production. The maximum payout is reached if maize production drops to 10% below the historical average.

“This weather derivative contract is just one instrument as part of a World Bank effort to deliver customized financial solutions and help members plan efficient responses to catastrophic events. The use of weather derivatives are most effective as part of a broader risk management strategy,” said Gloria Grandolini, Director of the World Bank Treasury’s Banking and Debt Management Department.

Juerg Trueb concluded: “The execution of the contract between the World Bank and Swiss Re demonstrates the ability and the interest of the international risk transfer markets to absorb such risks.” Swiss Re has used weather risk transfer in India in 2004 with a programme reaching 350,000 smallholder farmers.