Making the index link: how parametric solutions can help captives manage natural catastrophes risk

It is said that three in every four (or as many as 80% of) corporate insurance buyers have some form of exposure to weather-related risk. Natural catastrophes cause widespread devastation, tragic loss of life and huge economic losses. Last year, insured losses from natural catastrophes totalled more than $75bn, according to estimates.

Christelle Castet, climate risk specialist at AXA Climate in Paris, and Owen Williams, head of the captive centre of excellence at AXA XL in London, explain how parametric solutions can help risk managers to transfer weather-related risks and how captives can be part of the solution.

Q. Why does natural catastrophe risk pose such a challenge for risk managers?
Christelle Castet: Natural catastrophes remain among the biggest concerns for risk managers across the world. For physical assets, building codes are improving. But weather-related exposures are increasing, in part because of changes to the climate. And fluctuations in weather risk can have a disproportionate effect on the economic and insured losses caused by an event; a 10% increase in windspeed may lead to an even greater increase in damage caused – the damage bill may rise by as much as 30%, for example.

For many companies, natural catastrophes pose not only property risk but business interruption and supply chain risk – and these can even affect companies that do not sustain physical damage from an event.

Q. How do parametric solutions help to transfer weather-related risk?
Christelle Castet: Parametric solutions offer an index- or trigger-based method of transferring risk. The index is composed of one or more variables that are tightly correlated with the client’s damages. For instance, to protect against a tropical cyclone risk, a trigger can be based on the distance between the site insured and the track and intensity of a cyclone. Once a triggering event occurs and is verified, the contract pays out swiftly, providing a pre-agreed level of payment that is proportional to the severity or magnitude of an event.

The payout is not simply linked to physical damage but can offer coverage for non-physical damage business interruption losses, for example.

The good news for clients is that the trigger can be crafted around their specific exposure – for example, while some clients might suffer losses if a cyclone hits at high speed, another might be adversely affected if a cyclone slows once it makes landfall and this results in excess rainfall.

Triggers are developed by working with clients to understand their exposures and are based on their location and vulnerability to the risk posed to them by changes in weather such as frost, drought and windspeed, among others. If an event occurs, the trigger is verified by independent trusted third-party data sources, such as the National Oceanic & Atmospheric Administration.

There is no need for claims adjusting, since the payment is contingent solely on the trigger being met. Parametric covers are fast and transparent.

Q. Are captive owners starting to use parametric solutions?
Owen Williams: We are certainly now seeing an uptick in interest from captive clients with regards to parametric solutions. 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.

As Christelle has noted, parametric solutions are well suited to natural catastrophe risks, including climate risk and earthquake. But there are other types of risk that can be transferred using this type of coverage too – if a trigger can be designed based on verifiable data. This gives captives another way to offset some of those newer or emerging risks that they may otherwise find hard to place in the traditional insurance market.

Q. What are the other potential benefits to captive owners of using parametric solutions?
Owen Williams: 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.

Benefits like these, coupled with the speed and certainty of payment that parametric solutions provide, mean that our team expects to see even more interest in these coverages from captive owners going forward.

Contributed by Christelle Castet, climate risk specialist at AXA Climate in Paris, and Owen Williams, head of the captive centre of excellence at AXA XL in London

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