Parametric potential but work still to do

Growing natural catastrophe risks have seen the (re)insurance market harden for such threats and this has led to increased interest in parametric insurance. But while the parametric potential is clear, risk managers will need convincing of the ‘new’ concept, says Adrian Ladbury

As risk and insurance managers around the world struggle to find adequate insurance capacity at acceptable prices in key lines such as cyber, D&O and nat cat risks, the global reinsurance sector sent a stark warning about future capacity trends in nat cat during the recent Monte Carlo Rendez-Vous.

In the face of rising nat cat losses and against the backdrop of financial market turbulence caused by Russia’s war in Ukraine, reinsurers are playing it safe and pulling back further from this critical line.

The leading insurers will have to follow suit, so risk and insurance managers will find securing adequate nat cat cover even more difficult over time.

The core problem for risk and insurance managers is that traditional techniques to cope with a hard market do not work so well with catastrophic risks.

Captives are enjoying a boom at the moment as risk and insurance managers seek to protect themselves from the rising prices and restricted open-market coverage trends.

There is positive talk among insurance supervisors and even governments (notably in France) about making it easier for corporates to use captives to help build a more resilient economy in the face of rising systemic risks.

But captives are really designed for frequency losses such as fleet motor, not catastrophic losses of the sort brought by increasingly extreme weather events. The level of capital required to cover such events in any meaningful way would be prohibitive.

Increased interest
For these reasons, there has been increased interest shown in parametric insurance of late, not least by leading carriers such as AXA, AGCS and Swiss Re, and specialty MGAs such as Paris-based Descartes Underwriting, insurtechs such as Skyline Partners in London and, of course, the brokers.

On paper, parametric insurance provides the answer to the capacity crunch in the nat cat market.

It brings alternative fresh capacity to bear in a relatively simple manner that theoretically avoids those time-consuming, expensive and embarrassing legal conflicts that tend to come with traditional insurance policies in complex areas.

Marco Adamo, senior structurer of IRS in the EMEA region for Swiss Re Corporate Solutions, recently told Global Risk Manager’s sister title Commercial Risk Europe why parametric makes sense currently.

“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 the challenges that the current environment is imposing on corporations,” he said.

“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 added.

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.

Big potential
Mario Tucholke, boss of the recently launched DACH regional arm of Paris-based parametric-focused MGA Descartes, also sees big potential, even in the conservative German market.

“With continued market hardening in recent years, pressure has been mounting on nat cat deductibles and availability of competitively priced capacity, all while corporates are urged to contain their premium spend. Risk managers, more than ever, have to challenge the balance between cost efficiency and building up individual risk covers for their dedicated perils of tomorrow,” he said.

“This context, and the reality of climate change, calls for a revolutionary approach to insurance cover. Descartes’ new generation of corporate cover meets the demand where the traditional market has fallen short – offering access to fresh capacity and leveraging new technologies to better assess, model and detect evolving exposures in near real time,” continued Tucholke.

“As a result, our covers are more transparent, more efficient, simpler and quicker to pay than corporate covers. We exist so that businesses and society can have trust in their coverage and continuity, despite the next disaster,” he added.

Firm figures about the current scale and potential of this market are hard to find, but, clearly it is big and growing. Skyline Partners, a private equity-funded UK insurtech company focused on parametric insurance, stated recently that the market makes up about 15% of issued catastrophe bonds in a $100bn market.

Research firm Allied Market Research claimed in a report published earlier this year that the global parametric insurance market is expected to reach $21.4bn by 2028, rising at a market growth of 9.6% CAGR during the forecast period.
Impressive numbers, but it is not clear where they come from. Wishful thinking from those who have invested in this market in recent times, perhaps?

Downsides
Despite these figures, anecdotal evidence suggests that the potential for this market remains undecided.

Maxwell at AGCS conceded that there is a problem with frequency, and thus, price.

“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.

Also, during several recent interviews carried out for Commercial Risk’s annual Risk Frontiers survey leading European risk managers were asked whether they see parametric insurance as a viable alternative in the current tough market.

The responses were not that positive. There appears to be a definite level of uncertainty about how applicable this alternative ‘line of business’ will be for the majority of corporations.

During a recent presentation on the potential offered by the parametric market during the GVNW German risk and insurance management association’s annual symposium, there was clearly some confusion among risk managers and brokers about how the coverage and claims payments in particular actually work.

The idea that the coverage is neatly simple because the claim is based on an independently verified trigger (level of rainfall, strength of wind, sustained temperature levels) became muddied as the question of indemnity and proof of loss was raised.

The bottom line seems that the customer cannot recover a higher figure than the loss suffered because that would effectively make it a derivative rather than an insurance policy, with regulatory and fiscal implications.

This means that the loss needs to be proven and verified, potentially taking away one of the core values of the product – simplicity, speed of payment and avoidance of legal dispute.

Whether this is really such a problem or not is currently not really that relevant.

Based on this discussion and recent interviews with sophisticated and experienced risk and insurance managers working for major European corporations, it is clear that the parametric insurance market has some marketing and education to carry out to convince customers that it is worth a try, despite the evaporating capacity.