Trigger happy: the rise of parametric insurance
Take-up of risk protection that responds to events rather than the insureds’ losses is accelerating, with parametric solutions increasingly complementing traditional indemnity insurance
The combination of Covid-19 and a hard insurance market, as well more frequent secondary perils in the natural catastrophe loss mix, is fuelling growth in the parametric insurance market.
Parametric risk transfer, which differs from traditional indemnity insurance because it is triggered by a pre-defined event or index, rather than the actual losses incurred by the insured, has been around for 30 years.
Usually associated with weather events, parametric insurance trigger indexes can be based on, for example, windspeed in a certain location, precipitation levels, or highs and lows in temperature.
In the past it has occupied a niche in property-casualty classes, typically to do with the construction industry or agriculture. However, brokers and carriers are experiencing an uptick in enquiries and more deals are being done - with a wider range of perils in play.
In one high profile case last month, Lloyd’s launched a new earthquake insurance policy in New Zealand, in partnership with insurance start-up Bounce, which uses real-time GeoNet data to automatically pay customers within five days following a strong earthquake.
The solution, which complements traditional insurance, uses shaking intensity as an index. It does this by tracking peak ground velocity (PGV), which triggers payment at levels of 20 centimetres per second and above.
In another deal last month, the world’s first catastrophe bond for volcano-related disasters was completed on behalf of the Danish Red Cross. The cat bond, which covers 10 volcanoes across three continents, will to raise up to $3mn from investors for aid in the aftermath of an eruption. It pays out whenever a volcanic ash plume reaches a certain height and the prevailing wind directs the ash fall towards vulnerable communities.
Daniel Vetter, head of North America for the Paris-based MGA Descartes Underwriting, says buyers and brokers have developed a better understanding of how parametric products work: “But the interest recently has been fuelled by changes in the commercial property and casualty marketplace. Primary carriers and reinsurers have cut back capacity, tightened terms and conditions and buyers and brokers need to fill those gaps.”
Paul Ramiz, director of Aon’s Innovations and Solutions team in the UK, says one reason for the surge in requests could be that organisations’ cashflow and liquidity is under pressure due to the pandemic: “The situation has highlighted the benefits of parametric insurance – parametric solutions have an efficient and transparent claims process; a hurricane loss can be settled in 30-60 days whereas an indemnity claim might take 18 months.”
Parametric insurance is an “excellent add-on” to indemnity based insurance products, according to Gianni Biason, head of Property & Specialty Solutions at Swiss Re: “They increase coverage and reduce potential protection gaps, give immediate financial relief to [insurer] clients or corporates and can cover some unexpected losses, combined with an improved client interaction and a potential to digitalise insurance products even further.”
There’s another spin-off benefit for carriers, Biason says: “Parametric insurance uses access to third party data for validating a loss. In that sense an insurer can use the same data points to have a first view of their potential loss scenarios for a traditional indemnity-based insurance product. This can be helpful to validate losses quickly also on a portfolio level and improve and speed up the damage assessment.”
Bigger and better?
Parametrics usage now extends from primary placement of property insurance to excess of loss reinsurance or a quota share programmes. According to Aon’s Ramiz: “You can reinsure captives or write consumer and commercial business relating to hurricane cover and flood, for example. The largest placements we write are reinsurance deals with limits in the hundreds of millions.”
Supply is booming too. Where there used to be just a handful of reinsurers underwriting parametric deals Aon now counts over 45 markets including reinsurers, insurers and hedge funds.
Descartes writes on Generali paper mostly but has access to other carriers, Vetter says.
“Our experience is that it’s attractive to (re)insurers for portfolio diversification. For the risk carriers we’re working with, creating a value proposition for the parametric market themselves would be costly and time consuming. Therefore, lending their balance sheet to a company like Descartes is viewed to nicely complement their existing P&C portfolios.
“Also, it offers players an opportunity to capture business that they may be losing on the traditional side,” Descartes adds.
While most parametric insurance deals are made around weather indices (usually wind or temperature), other perils like cyber and non-damage business interruption are being explored.
If there is a good data set to structure the insurance it’s possible to create a parametric policy. Room rate indices for hotel chains, for example, that react to various events, have been used as the basis for solutions to protect against loss of revenue caused by a specified event.
“We are relatively agnostic to the event type – so long as it has good, independent data history,” Aon’s Ramiz says.
Gabriel Gross, Parametric Solutions director at Cooper Gay, says that brokers are increasingly asked to find new enterprise solutions: “A business client that relied on tomatoes [for its products] saw a sudden spike in wholesale tomato prices caused by weather volatility. It’s not a risk that the financial markets could handle; the only counterparties available were reinsurers and ILS funds.”
In another example, a large corporate client had a multibillion limit insurance contract that had an eight digit sub-limit for one specific supply chain disruption risk, linked to fluvial navigation for transportation of goods, Gross explains: “The risk was the river water level (too low or too high). It was a problem for their insurer in the context of its coverage programme – but it was an opportunity for us.”
Gross thinks the evolution of parametric products as a complement to traditional indemnity insurance will continue.
“The argument in the past was for one insurance contract with everything in it. This is changing. Corporate clients and public sector buyers increasingly see risk hedging as a management tool.”
The pros and cons of parametric insurance
Parametric plus points
• Speed of payout: transparency about when a payout is due, and when it isn't
• Lower cost of risk: a simplified claims process and absence of loss adjustment
• New products: increased potential for digitising solutions
• Complementary cover: closing protection gaps in indemnity programmes
• Basic risk: limited correlation of the index that triggers the payout and the actual loss can result in negative basis risk (actual loss is larger than payout) or positive basis risk (actual loss is smaller than payout)
• Regulations: some regulators treat parametrics differently, which has to be reflected in the design of the product, or product details have to be discussed with regulators beforehand
• Data: lack of an independent third party data provider to act as a reporting agent to verify the loss