Focus: Parametric covers are an increasingly viable solution for US nat cat risks
The Insurance Day
Pandemic-driven advances in data analytics, modelling and remote monitoring technologies have significantly broadened the application of parametric covers for nat. cat. events through digital platforms.
With the escalated impact of climate change, frequency and severity of weather-related events which continue to cause disruption to businesses across different geographies globally, re/insurers remain the primary risk transfer mechanism for global companies facing natural catastrophe events.
While re/insurers continue to underwrite their risk portfolios providing coverage against these events through more traditional property risk transfer structures, many leading re/insurers can provide alternative client solutions offering bespoke specialist capability such as parametric re/insurance cover.
Re/insurers have provided parametric solutions for some time, however, there is now a greater relevance and wider choice available to businesses for complementary or alternative structures to transfer risk in what can be, or is becoming, a very challenging environment for businesses to manage.
Parametric cover works differently to traditional insurance coverage in that they are index-based solutions that cover the probability of a pre-defined event happening instead of indemnifying actual loss occurred. It is an agreement to make a payment upon the occurrence of a triggering event, and as such is detached from the underlying physical asset. The key criteria for an insurable trigger are that the event is fortuitous and can be modelled.
To outline the difference between traditional insurance and parametric, there is a clear distinction. Within the traditional market, a customer pays a premium based on the coverage type and coverage amount. However, within the parametric model, the customer premium is based on pre-defined parameters of one or more triggering events and coverage amount. This trigger event occurs when its parameters meet or exceed those defined in the insurance agreement.
The speed of the claims process also acts as one of the clearest advantages of the parametric approach. In traditional insurance the insurer pays out weeks or months after loss assessment and investigation. The parametric model, in contrast, is based on defined event parameters; once the claim is triggered, the confirmation is swift, and payment is virtually instantaneous.
Risk appetite and capacity
Parametric cover can be especially useful when there is a lack of capacity or appetite from traditional insurance markets where risks may become uninsured.
An index is chosen by the insured along with the thresholds and the pay-outs adapted to the risks. There’s an independent source of data which is monitored to see if the cover is triggered. Once triggered, the insured confirms their losses and receive payment.
Parametric insurance however is not a financial product. An insurance contract cannot pay more than the insured’s actual losses in the case of a claim. Without an insurable interest, no insurance contract can be legally enforced.
The benefits of a parametric solution can provide more predictability for businesses with a pre-agreed payment structure resulting in an efficient and timely settlement process providing revenue and balance sheet protection enabling quick access to capital when the event occurs. Furthermore, parametric can provide non-physical damage business interruption cover which can be critical to a business if there is an interruption to the business following an event yet no direct damage incurred.
Flexibility to provide single year or multi-year coverage provides certainty over an extended period and can be an ideal alternative way for captives to transfer retained risk via a bespoke parametric solution.
There are many industries where a parametric solution is a viable option whether in the food and beverage sectors. to agriculture, or transportation. Whatever the sector, parametric insurance is relevant when covering natural risks including frost, drought, heatwaves, yield protections, hail, snowfall and wildfires, particularly in North America.
For example, a loss to a US vineyard from a wildfire cannot only damage the facilities and equipment but also the vines.
This can lead to a loss of product supply and potentially several years of lost harvest or even without direct fire damage there is the potential of smoke taint, all resulting in potential loss of revenue to the winery.
By using historical wildfire data and an insured’s value per hectare, a parametric solution would provide a structure whereby an index is applied to a number of hectares with minimum and maximum thresholds with a set pay out per hectare within these thresholds.
Parametric solutions are the way forward post-pandemic.
Increased demand for parametric solutions is driven, in part, by the pandemic-related volatility as insureds increasingly focus on solutions that can rapidly deliver pay-out that enable business continuity.
Furthermore, advances in data, analytics, modelling and digital technology are accelerating the availability and transaction process for a broader commercial offering with a number of specialist re/insurers providing niche products through digital platforms.
