Parametric market to grow as corporates seek emerging risk solutions

The market for parametric insurance is set to grow as corporates look for solutions to emerging and non-traditional risks like climate change and non-damage business interruption (BI), experts have told Commercial Risk.

Parametric solutions, which pay out when a pre-agreed threshold on an index is reached, can help risk managers address today’s complex and fast-changing risk environment, said Marco Adamo, senior structurer of IRS in the EMEA region for Swiss Re Corporate Solutions.

“Parametric insurance is an innovative and efficient way to respond to ever-changing customer needs. With their breadth of cover, they are a very powerful tool to fill the gaps in traditional insurance and tackle those challenges that the current environment is imposing on corporations,” he added.

“Because they [parametric solutions] are independent from the underlying type of risk, they offer the possibility to tackle those risks that are difficult to insure and indeed fill the gap that traditional insurance is leaving behind,” he said.

Grant Maxwell, global head of alternative risk transfer at Allianz Global Corporate & Specialty (AGCS), is also optimistic about the potential for parametric solutions. “We can expect this segment to steadily grow, in particular in peak risk areas such as cyber risk or natural catastrophes and weather risks, and where risk is ceded to the capital markets,” he said.

“This type of insurance is ideal for companies with diverse risk portfolios and multinational exposures – especially in the energy market but in other industries, too. For example, almost every industry – construction, energy, agriculture, aviation, retail, mining – has weather exposures,” Maxwell continued.

Parametric insurance is particularly well suited to addressing risks emerging from climate change, according to Adamo. Swiss Re Corporate Solutions is offering parametric solutions for flood- and drought-related risks, without the need for physical damage. For example, its index-based water-level insurance, known as FLOW, was used to structure a BI cover based around river gauge readings in central Europe. The product pays out when water levels go too low or high for barges and other vessels to trade safely.

“Climate change is a reality and is showing its effects earlier than expected with increased severity and, most of all, frequency of extreme weather events. Exposure to natural catastrophes suddenly becomes more important and items such as extra expenses, removal of debris, BI and CBI make the top of corporations’ priority list. This is where parametric insurance is a very good fit,” said Adamo.

The use of parametric covers varies but often involves weather-related exposures, said Maxwell. AGCS, for example, has used parametric triggers to protect green energy operators against below-average wind speed or sunshine. It also been used to cover farmers against excess or lack of rainfall, and extreme heat and cold. The insurer has also provided cover to an aircraft de-icing company that pays out when the number of “freeze” days at specific airports is below a threshold.

Parametric covers can help with emerging risks when traditional risk transfer solutions are not available, said Maxwell. The options are typically investigated when (re)insurers are limiting capacity, or a company has an exposure but no clear risks or assets that can be indemnified, he explained.

“Weather and disaster risks are a typical use case for parametric solutions but they also can be used for other exposures. For example, if a retailer’s income plummets because of reduced footfall in a city shopping district, for example following a political disruption, a payment can be made. Parametric policies also can be structured to cover non-physical damage risks and, potentially, reputation risk,” he said.

Parametric insurance might not currently provide the solution to all emerging risks but where data is available and reliable, the possibility to structure a parametric insurance product increases drastically, said Adamo.

“We at Swiss Re Corporate Solutions are committed to finding solutions that are tailor-made to our customer needs. One example worth mentioning is the possibility to use company volumes data as a benchmark of the business interruption – a solution that can potentially solve the many challenges that corporations face in the settlement of BI [claims],” he said.

Swiss Re Corporate Solutions has provided a US hotel company with non-damage BI cover against ‘black swan’ events, including terrorism, acts of civil authority and widespread travel disruption. The parametric solution, which uses an independent hotel industry index, pays out when a named perils occurs and the industry ‘revenue per available room’ index decreases by 10% or more from the same month in the prior year.

The Zurich-based insurer also developed a parametric non-damage BI solution in Asia for severe haze events caused by forest fires. The product indemnifies businesses in Singapore against earnings volatility caused by reduced footfall, forced shutdowns and additional operating costs stemming from a severe haze event. Payouts are pre-agreed and based on Singapore’s Pollutant Standards Index.

“As the world becomes more complex, businesses are facing extraordinary challenges due to increasing uncertainty and sophistication; topics such as liquidity management and filling the protection gap are ranking high on priority lists and insurance transparency is already paramount to ensure adequate capital management. In my opinion, those are factors that provide fertile ground for parametric insurance to grow and evolve as the risk landscape changes,” said Adamo.

One of the key benefits of parametric insurance, which can be standalone or support an existing structured insurance solution, is its ability to make fast payouts, explained Maxwell.

“Parametric solutions don’t need detailed investigation to determine the actual loss. They can generally be calculated quickly using readily available data, leading to quicker payment. Parametric solutions also allow for quantification of loss that may be otherwise impossible – such as using satellite data for weather indices or a proxy index such as transport passenger numbers to represent potential customers for a retailer,” he said.

Parametric coverages typically pay out based on measured parameters rather than directly assessing the actual loss suffered by the buyer, said Maxwell. “Such indices are typically simple and transparent, leading to fewer disputes. They also avoid the need for the insured to regularly provide detailed and updated information during underwriting and after a claim,” he said.

Parametric contracts also make ceding risks to the capital markets simpler and easier, explained Maxwell. “They can simplify bringing new capital from outside the (re)insurance industry to bear on peak risks where (re)insurance capacity is either not available, or where ceding to the (re)insurance market is very expensive due to such peaks driving up the risk-adjusted capital. Their transparency and lack of need for complex underwriting information makes secondary trading easier, and hence improves investment liquidity and reduces price,” he said.

But parametric solutions do have limitations, Maxwell said.

“When considering parametric solutions however, one must consider that loss expectation drives premium. Experience has shown that often people seek to cover events on a parametric basis that give a total loss fairly frequently, say every five years. Unfortunately, they are shocked when the premium comes back at greater than 20% rate on line. One should always take the time to consider how frequent the events are before asking for a quote. The more common and frequent an event is, the more expensive parametric solutions are,” he said.