Demand for parametric insurance products is rising in the hard market, and as companies place more value on cashflow, according to Aon.
Interest in solutions for ‘black swan’ events and intangible risks may also drive future demand in parametric products, Paul Ramiz, director of Aon’s innovations and solutions team, told Commercial Risk Europe.
Risk managers have significantly increased their interest in parametric insurance products during the past 12 months, according to Mr Ramiz. Awareness and understanding of the product have risen among corporate insurance buyers, while the hard market for commercial property insurance is making parametric products more competitive, he explained.
“Risk managers are better educated on parametric products, while the increased rates, reduced capacity and stricter terms and conditions in the insurance market mean that prices for parametric solutions are now on parity with the traditional market in some circumstances,” said Mr Ramiz.
Parametric contracts – which are triggered by an event or index, rather than actual damage suffered – are supported by a range of capital sources, including both traditional and capital market capacity. They are typically structured to address weather events, such as storms or extreme temperatures, although they can theoretically be applied to a wide range of perils and risks where good data and indices are available.
The hard insurance market has led to a “surge” of interest in parametric products, with some buyers replacing traditional programmes with parametric covers, according to Mr Ramiz. In June, a leading US telecoms company replaced its entire traditional property indemnity programme with $300m of hurricane coverage through a parametric solution.
“It is worth risk managers taking a look at parametric products to see if there is a cost or efficiency benefit when compared with traditional insurance. They may be able to buy the same level of protection but at a lower cost,” said Mr Ramiz.
Parametric products have been used to hedge risks in the energy sector for decades, particularly for abnormal periods of cold or hot weather. They have also been used to cover natural catastrophe and crop exposures in emerging markets.
Interest in parametric solutions has been most evident for natural catastrophe risks facing large corporates, and in particular US hurricanes, explained Mr Ramiz. “Demand for parametric triggers is growing consistently among corporates and I would expect it to continue in 2021 as more risk managers find uses for them,” he said.
Christopher de Wolfe, global director of risk management at multinational manufacturer Mars Incorporated, for one, believes parametric solutions will be “the next cool thing” for the risk management and insurance industry
A parametric trigger can be used to cover property damage, such as earthquake, flood or windstorm. But it can also be used to cover the consequences of events, such as a storm, cyber incident or, potentially, an infectious disease outbreak, explained Mr Ramiz. Before the coronavirus pandemic, Aon had been looking at parametric indices linked to World Health Organization data.
Parametric products could also help companies prepare for future black swan events, in particular high-impact events where there is good data available, according to Mr Ramiz. One potential solution is to hedge against the adverse impact of such events, rather than the peril itself. For example, a hotel group could use a parametric product to hedge against a sudden drop in room occupancy rates, or an airline could protect itself against a big fall in global air passenger numbers.
“Black swan events are an unknown, but it may be possible to utilise data and indices to hedge against the potential impacts. With the pandemic, risk managers have been through a global event and will have more data on the impact on the business for similar events,” said Mr Ramiz.
Parametric products may also be able to provide some cover where traditional insurance cannot, according to Mr Ramiz. For example, since the pandemic, insurers have tightened up exclusions for disease outbreaks in traditional policies. Parametric products, in contrast, tend to be more inclusive.
“It’s early days but there is innovation in areas like non-damage business interruption, cyber, supply chain, reputation and intellectual property. These are areas where there could be parametric solutions. It’s all about getting the data, creating the index for the parametric trigger, and working with the market to underwrite them,” said Mr Ramiz.
Risk managers and insurers could also harness developments in data and technology to create indices for uninsured or difficult to cover risks, said Mr Ramiz. “There is more data now than ever,” he said.
Risk managers are beginning to embrace parametric solutions but these solutions require “more innovative” risk transfer strategies compared to traditional insurance programmes, according to Mr Ramiz. He expects parametric triggers to become commonplace, although they will not wholly replace traditional indemnity insurance.
“The future of risk management and insurance will be parametric layers in traditional insurance programmes. There will always be the need for traditional indemnity insurance products but parametric triggers will become more normal, due to the desire for cashflow and contract certainty, as well as the need to address emerging risks and intangibles,” said Mr Ramiz.
One of the main benefits of parametric products is the speed of payout. Parametric products generally pay out much faster than traditional indemnity insurance, where loss adjusting and claims settlement can take years. In comparison, parametric products triggered by an independent index typically pay within 30 days, but have been known to settle within 48 hours, according to Mr Ramiz.
Contract certainty is another consideration. Claim payments and values are more uncertain with traditional insurance, and are subject to exclusions and potential coverage disputes. Clauses in insurance contracts, such as replacement clauses, may also limit policyholders’ ability to spend claim proceeds freely. Parametric products, in contrast, allow buyers to spend claim amounts as they see fit.