Filling the gaps – the rise of parametric solutions for corporates

There is a growing interest in parametric solutions from corporates in recent times, driven by the challenging conditions in the traditional insurance market with rate increases, stricter terms and conditions, and capacity issues. That is particularly true for natural catastrophes and weather-related risks, which have become more complex, expensive and difficult to find coverage for. All of which has begun to make parametric solutions a more compelling and attractive proposition than ever before.

“Today, there is more and better data, as well as better expertise in modelling the correlation between different events and a client’s revenues and/or costs, which means these solutions have become more attractive for certain exposures,” says Marine Charbonnier, global programmes and captives regional director, Asia and Europe, AXA XL.

She notes that, not surprisingly, much of the growing interest in parametric insurance is coming from industry sectors that are most exposed to weather risk, including agriculture, renewable energy operations, construction, tourism, transportation and automotive.

Jan Bachmann, head innovative risk solutions, EMEA, Swiss Re Corporate Solutions (SRCS), says that critical natural catastrophe (nat cat) perils combined with shifting market dynamics have created a complex environment for risk managers, with available capacity fading, insurance prices rising and the scope of cover often diminishing. As a result, there is a growing interest in, and uptake of, parametric products, due to the need to fill the gaps of traditional programmes.

The most common parametric covers are the ones following a natural catastrophic event such as tropical cyclones, earthquakes, floods and other severe weather patterns, protecting against property damage, loss of earning/income, business interruption, extra expenses, loss mitigation expenses and business continuity expenses.

Bachmann says supply chain risk is a classic exposure where parametric insurance can offer effective solutions and carve-out critical exposure. But he notes that non-nat cat applications of parametric covers are coming up more and more, as new data and indices become available, supported by technology, “all of which is increasing the bounds of insurability as long things become measurable and traceable – think of all the sensors in IoT or financial data available”.

Main benefits
Parametric solutions have a number of benefits, according to Bachmann, not least full transparency, simplification of traditional insurance with a pre-agreed payout and payment within weeks, and products that are tailored for individual clients, providing certainty against specific events. And this often allows cover for events or risks that could not be bought on the open market or that were previously deemed ‘uninsurable’.

Bachmann also points out that it can add stability to the overall insurance programme by carving out critical nat cat risks, with a separate placement on a multiyear parametric basis, fixing the price for capacity across multiple years, and buying the rest of programme on a traditional indemnity basis with a large discount since the volatility has been removed.

“We want risk managers and their brokers to fully understand the potential gaps in their traditional insurance coverage. We work with them to place a value on those uncovered or difficult-to-insure risks,” says Bachmann. “The ‘magic triangle’ in parametric insurance is speed, flexibility in how payout can be used, and transparency. We like to say there’s no fine print in a parametric policy. The wind blows or the earth shakes, and you collect. That’s a reassuring way to stay viable in these uncertain times.”

AXA XL’s Charbonnier agrees, pointing to three main benefits of parametric insurance for private sector clients: objectivity, speed and customisation. “Firstly, parametric solutions are objective. They are based on pre-agreed index values deriving from independent third-party data, which means policies aren’t subject to interpretation or conditions. Secondly, parametric insurance solutions are fast and efficient. Once a pre-agreed threshold is reached, claims can be paid in days or, at most, weeks.”

She adds: “Finally, parametric solutions are tailor-made; each is tailor-made. Each policy covers specific locations or facilities defined by the client, and the individual programme structures – index values, payout formula and coverage limits – are customised to the client’s strategic objectives, risk appetites and budgets.”

Captive vehicle
Captives have long been talked about as a potential vehicle for parametric solutions. As the hard market continues to bite and corporates turn increasingly to their captives, larger, mature captives are increasingly looking at such solutions to fill gaps.

“We are certainly seeing an uptick in interest from captive clients with regards to parametric solutions,” says Charbonnier. While trigger and index-based solutions are not new, this is an innovative and developing part of the insurance market and there is definite interest from sophisticated risk managers who tend also to have captives as part of their risk management strategy.”

She adds: “Adapting parametric coverages into captives can have numerous benefits for captive owners. For one thing, the access to parametric expertise, which is specialist, rare and constantly developing, can enable captives to accept risks that they would not ordinarily be able to underwrite. And in so doing, they can build up more powerful data on those risks and become an even more useful tool in their owners’ overall risk management strategy.”

SRCS’s Bachmann has also seen a clear uptick in interest around applying parametric policies within a captive. “The problem, however, lies in implementing parametric covers within a captive. This is a more complicated process because the question is: how does the captive transform the coverage they buy on a parametric basis into the coverage of the captive’s insureds?” he asks.

He explains that the result of a parametric policy is a fixed payout based on the parametric trigger. Therefore, there may well be a difference between what the parametric cover pays and what the loss involves on the insured’s side. “This leads to another question: can the captive pass on that basis risk to the insured? If yes, then the captive, in its coverage towards the insureds, just reflects the basis risk that comes from the parametric cover they buy from the market,” he says.

“On the other hand, if the basis risk is not acceptable to the insureds and they want 100% indemnification for the losses they have, the captive might actually act as the transforming entity and, assuming the capitalisation of the captive is large enough, the captive might accept the basis risk coming from the parametric (re)insurance and still provide indemnity insurance on the front end to its insureds – a case of the captive transforming this parametric basis risk into an indemnification coverage. If there is any gap inbetween – whether the parametric payout is more or less – the captive would itself take the basis risk on,” Bachmann says.

AXA XL’s Charbonnier stresses that parametric insurance and traditional insurance can provide robust balance-sheet protection, and the suitability of one versus the other depends on a range of factors specific to individual clients. And Bachmann adds that parametric solutions can fill gaps found in traditional indemnity policies – like deductibles, sub-limits and exclusions: “In that sense, parametric insurance policies are complementary to, rather than replacements for, traditional insurance programmes when it comes to addressing shortfalls in coverage,” he says.

As Bachmann points out, there have been huge advances in technology and data collection, and this makes the parametric value proposition more compelling as monitoring and measurement of the natural world becomes more precise, which in turn makes pricing risk more possible and the case for mitigation measures clearer.

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