Going parametric – specialty risk

The vast majority of parametric insurance deals struck in the past few months in Asia have been around natural catastrophe and weather-related risk. For example, in June, three insurers – Aswat, Mercy Corps and Swiss Re – collaborated on the first parametric insurance solution for Indonesian provinces, to provide cover for microfinance institutions in Aceh and West Sumatra that may suffer portfolio losses in the event of an earthquake. Swiss Re was also involved in the first parametric farm insurance product in China, which started in August. The reinsurance scheme, which involves the government of Heilongjiang Province and the Sunlight Agriculture Mutual Insurance Company of China, is the first time the Chinese government has employed commercial insurers to provide nat cat cover for farmers and also the first insurance deal in China to combine a weather index product with a satellite-based flood parametric product, says Swiss Re. Parametric insurance products also have the backing of the World Bank, which has pushed the insurance industry to develop more innovative products to address the growing threat from climate change and to build resilience against natural catastrophes, especially in Asia. To this end, the World Bank managed the development of the Global Index Insurance Facility, an online resource for index-insurance practitioners around the globe.hideDedicated divisions Customised insurance programmes have always existed in the corporate insurance markets but a number of insurers have formalised the provision of these bespoke policies and programmes in recent years, creating dedicated divisions for non-standard insurance programmes. Swiss Re Corporate Solutions (SRCS) set up its Non-Standard Solutions (NSS) unit, following a restructure in 2010. The NSS unit has 12 people working in four regions – north America; Europe, the Middle East and Africa; London; and Asia-Pacific (APAC). It currently accounts for 10% of the SRCS total premium income. A dedicated team for APAC was set up in 2014, based in Singapore and with the objective of establishing a regional business. “APAC is a very fragmented market, with different regions at different levels of maturity,” says Christian Wertli, global head of NSS. “Next to ANZ, Japan and South Korea, there are the big economies (China and India), the ones in-between (HK and Singapore) and then the developing markets (Vietnam and Thailand). The different countries are in different economic cycles, so our solutions are customised [and] we have to look at the local economies and the dynamics involved.” To date, NSS has closed more than 25 transactions in the region, many of which are in Japan covering earthquake risk and employing parametrics. “We do a lot of earthquake business where we use parametrics and the policies pay out based on the intensity of the earthquake,” says Mr Wertli. “This is a relatively mature and well established policy within Japan but now we are writing the same kind of business in other countries like the Philippines and Australia, and for extreme weather rather than just earthquakes.” For example, a semi-conductor company in Queensland that was traditionally uninsurable when it came to high winds and extreme weather risk was able to find coverage through a parametric-based insurance programme. Another example is a Philippines-based power company that used parametrics as the basis for its policy. “These are all companies looking for cover and traditional insurance does not give them the cover they need for certain risks,” says Mr Wertli. “So it is insuring the uninsurable.” Nat cat usage cases The use of parametrics has proved to be particularly suitable for natural catastrophe risks. The policy can define a certain area and then a certain threshold (say a figure on the Richter scale) and then deliver a pre-arranged payout based on the severity of the event and provided it occurs within the pre-defined area. It is a policy that has been referred to as ‘cat in a box’. “The big advantage is that it is an objective rather than subjective way to provide insurance,” says Mr Wertli. “You don’t need a loss adjuster and it facilitates a quick payout.” “We use the same frequency curve for both types; there are not different sets of data for pricing, so this product should cost the same as traditional insurance. For any kind of insurance you have to understand the underlying exposure but with traditional insurance, the challenge is to estimate the likely cost of an event and link it to the severity of that event. When it is not possible to do this accurately enough, the risks become uninsurable. “With parametrics, we don’t have to estimate the severity and if we set a pre-defined area, it contains the exposure. So rather than trying to assess the damage, we only have to rely on two objective and measurable factors – frequency and severity,” says Mr Wertli. SRCS has also used parametrics for other weather-related exposures, such as the Thai floods, bushfires in Australia, or high winds in India and China. “We look at where there is nat cat risk and where we have clients and where the two may overlap,” says Mr Wertli. While this means that parametrics are not really offered in Singapore, where there is little nat cat risk, they could prove to be crucial in the effort to close the protection gap for nat cat insurance in Asia. Supply chain and BI SRCS is also receiving a number of enquiries about applying parametrics to supply chain risk and contingent business interruption – another risk that has proved challenging for traditional insurance policies. “Companies can get cover for their own branches and businesses. The problem is when you want to cover suppliers that can’t provide underwriting data. We can now cover those suppliers with parametrics,” says Mr Wertli. As useful as parametrics are for certain kinds of high-level exposure, they are not best suited to every type of exposure, such as low level and high frequency events where traditional insurance is more apt. Furthermore, there are certain aspects that have to be agreed between insured and insurer for the policies to work effectively – not least the choice of index on which the policy will be based. Ideally, this index would be provided by a third party rather than the insurer, says Mr Wertli. “It is important that you have an objective data provider that can provide data quickly after an event. A good source is the Japan Meteorological Agency, which has dozens of weather stations. We also use them for Philippines weather risk.” Insurers are developing their own indices as well though. Swiss Re does so through its Sigma division and Mr Wertli says this is a reflection of the progress that has been made in terms of risk modelling and data, which in turn has helped to create indices and also help make underwriting more accurate. “Now we are looking to cover multiple perils and to use the insurance-linked securities market and make other risks more index-based and applicable to parametrics.” In addition to continuing to develop the technical aspects of parametrics-based insurance, the industry is also trying to work on its marketing of the products and to raise awareness among risk managers of not just how these policies work but that they exist in the first place. Fortunately, says Mr Wertli, there are a growing number of risk managers emerging that are more mathematically minded, akin to the emergence of quantitative analysts in the investment banking market in the 1990s. “There is a new breed of risk managers in Asia, not the same 60-year-old London market guys doing some risk management work in APAC before they return. They are LSE-educated and want to know about the future, the use of technology, modelling and other sophisticated techniques.” Insurers are also trying to emphasise that parametrics-based insurance is applicable to every industry – agriculture and food; construction and infrastructure; general real estate and property that is weather impacted – leisure, tourism, distribution/transmission lines. Furthermore, parametrics can be used with and not instead of traditional insurance, says Mr Wertli. “Parametrics-based solutions are financial instruments, so different tax and accounting rules apply and a license is needed to conduct the business. But it can also be underwritten with insurance or else split 50/50. It is really down to the preference of the corporate. If you talk to the risk manager, they want an insurance contract, if you talk to the CFO, they want a derivative.” Axa works on a number of different parametric subjects in Asia, including agriculture and energy. In 2016, it launched an agricultural insurance product in Indonesia to protect smallholders against drought risk. And in India, Axa participated in the recent national agricultural insurance scheme covering farmers’ kharif and rabi crops against drought and flood risk.On a corporate level, Axa also works with renewable energy companies in China and has devised solar radiation and wind speed indices to protect their energy production. Axa has strategically targeted Asia for parametric insurance as it is a large market with numerous, weather-sensitive industries booming, says Tanguy Touffut, head of parametric insurance, Axa Corporate Solutions. “Parametric insurance, being tailor-made and available even in the most remote locations at a low cost, is a particularly apt product for this diverse and rapidly growing market. Indonesia has great potential for parametric insurance as it has approximately more than 30 million farmers that are highly exposed to weather risk.” India is the largest parametric insurance market for agriculture and, thanks to the involvement of the Indian government, more than 12 million farmers are insured under parametric insurance today. Meanwhile, countries like China and the Philippines are also looking at parametric insurance as a risk mitigation tool for industries such as agriculture and energy. The fact that Asia is so prone to natural catastrophes makes parametric insurance particularly applicable, says Mr Touffut. Four Asian countries – the Philippines, China, Japan and Bangladesh – are the victims of more natural disasters than anywhere else on Earth. However, there are additional climate-related risks beyond natural catastrophes, says Mr Touffut, notably weather anomalies such as abnormal levels of rainfall or abnormal temperatures, that have increased in frequency as a consequence of climate change. “Their frequency has actually multiplied by five in the past 50 years,” says Mr Touffut. “Many industries are highly affected by these weather anomalies – their revenues or, in the case of agriculture, yield, are directly impacted by abnormal weather. Parametric insurance helps these different ‘weather-sensitive’ sectors circumvent weather-related losses.” The take-up of parametric insurance among Asian corporates is still relatively modest, says Mr Touffut, mostly because it is a new product with fundamental differences from conventional insurance programmes. “Unlike traditional insurance, parametric insurance does not indemnify the pure loss but agrees upstream to make a payment upon the occurrence of a triggering event. There is no need for claims adjusters or other costly processes. Parametric insurance is also entirely tailor-made and thus, very valuable for the insured. As the advantages of parametric insurance become recognised, varying from country and industry, among other factors, the take-up is increasing greatly.” Innovative approaches One of the main obstacles to wider adoption of natural catastrophe insurance across Asia has been affordability and the speed of payout. Innovative approaches have been adopted by the insurance industry to address these issues, says Mr Touffut, such as a greater number of public-private partnerships between governments and international institutions, including insurers. “It is very likely that the market will develop greatly in Asia in the coming years as advances in technology, including more sophisticated satellite images as a data source as well as improved Big Data processing methods, will make the products even more precise.” A greater acknowledgement from governments and other stakeholders of climate change and its adverse effect on populations, companies and wider economies, is also driving greater demand for climate risk mitigation and insurance solutions, including the use of parametrics, says Mr Touffut. Governments may be leading the way in market development but large corporates are also contributing to increasing market sophistication. “Through improved technology and increased public-private partnerships, we expect parametric insurance to develop greatly in Asia,” says Mr Touffut. “Additionally, as populations are increasingly urban, with a majority of people residing in cities, building resilient cities is key. Extreme weather in densely populated urban areas usually causes the most damage and it’s important to develop insurance solutions that can contribute to mitigation plans, through insurance but also through prevention strategies. Indeed, as insurance companies process weather data and monitor trends, they are able to contribute to mitigation and contingency plans as a means of protecting populations and economies.” As insurers look to increase adoption of parametric insurance, their efforts are likely to focus on property and construction lines for power-generating companies, operators and contractors. Axa and its Matrix Risk Consultants unit are actively consulting with energy sector clients around the benefits of index-based coverage. “Parametric insurance is a very interesting development for those clients. It demonstrates we want to go one step further than expert P&C insurer in the powergen/energy sector. We wish to provide alternative solutions so they are able to manage a broader range of risks,” says Mr Touffut. “For example, regarding the production of renewable energy, parametric insurance covers against lack of wind (wind farms), solar radiation (solar farms) or precipitation (hydropower). Axa Corporate Solutions uses data provided by Nasa, which is free and available worldwide. Regarding the consumption of energy, we can cover against cool summers that will lead to a reduced use of air conditioning and therefore a decrease in energy consumption. In both cases, it could be an insurance product or a weather derivative supported by our Axa Investment Managers entity in Asia.” Get with the global programme In addition to the use of parametrics and catastrophe bonds, insurers are also pushing for a greater use of global programmes by their Asian clients. Allianz Global Corporate and Speciality (AGCS) has its Asian headquarters in Singapore and operations in Mynamar, India, Japan, China and Hong Kong. Within the AGCS portfolio is the International Insurance Solutions (IIS) division, which provides insurance coverage for clients with complex business risks that require a global response, says Mark Mitchell, AGCS regional CEO, Asia. “Most of our clients are large companies with international exposures that have technically challenging risks and high value coverage,” says Mr Mitchell. “We provide cover for risks in more than one country via a master policy plus locally admitted policies placed with Allianz companies.” IIS has more than Ä1.5bn in premiums and manages 2,500-plus international insurance programmes, with 18,000 local policies included within these programmes. The demand for international programmes is primarily being driven by globalisation, says Mr Mitchell. The number of multinational companies has grown from 7,000 to almost 104,000 during the past 50 years and is expected to reach 140,000 by 2021, causing additional risk complexity. But Mr Mitchell says a more recent trend evident from the use of international programmes is that it is no longer only US and European companies that are entering global markets. “More and more companies from Asia and other emerging markets are expanding worldwide to serve their customers in different markets and organising themselves as global companies. These companies are not just looking for a capacity provider but a partner who can accompany them on their international expansion, with adequate insurance cover.” Global programmes offer clear advantages for companies, says Mr Mitchell. “Centrally controlled, multinational insurance programmes cover the customer’s global risks by providing consistency and transparency of coverage while at the same time matching individual local business and market requirements. They also provide the advantages of centrally managing the purchase of insurances globally and facilitating administration, consolidation of loss reports and coordination of loss control and risk management procedures.” This is not to say that international programmes do not have their challenges, the biggest of which is ensuring compliance with local regulations, particularly in a fragmented market such as Asia. “Emerging markets are especially challenging to operate in, since they have very national-oriented and restrictive rules in place,” adds Mr Mitchell.

Going parametric – specialty risk

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