Rainfall contract – derivative financial instrument or insurance contract?
Company E has contracted to lease a stall at an open-air event from which it plans to sell goods to people attending the event. The event will be held at a village approximately 100 km from Capital City.
Because E is concerned that poor weather may deter people from attending the event, it enters into a contract with Financial Institution K, the terms of which are that, in return for a premium paid by E on inception of the contract, K will pay a fixed amount of money to E if, during the day of the event, it rains for more than three hours at the meteorological station in the centre of Capital City.
The non-financial variable in the contract, i.e. rainfall at the meteorological station, is not specific to E. Particularly, E will only suffer loss as a result of rainfall at the village, not at Capital City. Also, because the potential payment to be received is for a fixed amount, it might not be possible to demonstrate that E has suffered a loss for which it has been compensated. Therefore, E should account for the contract as a financial instrument under IAS 39 (IFRS 9).