Reading basis risk with a ruler

Every index policy has a gap between what it pays and what you lose. Insurers call that gap basis risk, and most descriptions of it stay abstract. It is easier to understand with a map, a ruler and the last three events that hurt your site. You can do this in an hour, and you should do it before you buy anything.

Step one: find your cell

Look up the cell that contains your site. A cell is a square 10 by 10 kilometres, and our quote tool shows you its identifier and a reading history. Mark your site on the map. Then mark the cell edges, and note how close your site is to them. A site 800 metres from an edge is, for practical purposes, in two cells.

Step two: replay your losses

Take the last three losses you had to deal with, and write down the date and the cost of each. Next to them, write what the cell read on those days. If the cell read 143 km/h on the day your roof lost its sheeting, and your strike would have been 150, you have found a gap of 7 km/h. That gap is your basis risk for that event, and it is a number you can reason about.

Step three: measure the neighbours

Repeat the exercise with the four cells that touch yours. If a neighbouring cell crossed the strike while yours did not, the storm was close enough to matter and not close enough to pay. A site that borders many such cells is a candidate for a lower strike, or for a second policy on a different index, such as Rainfall, next to the first.

Step four: choose how much gap to carry

A lower strike pays more often and costs more. A higher strike pays less often and costs less. The question is how much of the gap you can carry on your balance sheet. A hotel group with a large cash reserve may choose a strike of 160 km/h and carry the gap. A cold-store operator with thin margins may choose 142 and pay for the certainty.

What we do about it

We do not remove basis risk. We try to make it visible before the sale. Every quote carries the replay of ten years of the cell against your own records, and the Policy Disclosures page explains how to read it. If the gap is too wide to be useful, we say so and suggest a different cell, a different index or no policy at all.

A last tip

Do not try to eliminate the gap entirely. A policy that tracks your losses perfectly is a property policy, and it has the costs of one. The point of an index is that it pays quickly on something nobody can argue about. A ruler, a map and an honest hour are enough to decide whether that trade suits you.