Risk managers turn to parametric solutions as protection gap widens

Parametric coverages are rapidly becoming an essential part of the risk management toolbox, as organisations the world over struggle to meet the threat of natural catastrophes and difficult-to-insure emerging risks that fall outside of traditional insurance lines.

Parametric insurance solutions are not an all-encompassing panacea that will replace traditional insurance and reinsurance. But as the market becomes more aware of, and comfortable with, these tools, they could play an important part in the effort to bridge the still-worryingly-high protection gap.

These were the core conclusions of a lively webinar – NatCat trends accelerating parametrics – hosted by Commercial Risk in partnership with Aon in the lead-up to our fifth Construction Risk Management Europe conference in London on 23-24 April.

Natural catastrophe risk is clearly a major concern for risk and insurance managers in the construction sector and so this topic will form a major part of this market-leading event.

The Aon team – led by moderator Simon Simpson, managing director of construction and infrastructure at the broker, and joined by Daniel Vetter, head of North America at Descartes Underwriting – helped guide risk managers through what remains fresh ground for many.

Cole Mayer, head of parametrics at Aon, and Mike Van Slooten, head of business intelligence at the broker, who gave the reinsurance perspective, also joined in the debate.

As Mayer pointed out, the fundamental problem and spark for the growth in parametric solutions is the widening nat cat protection gap.

As nat cat exposures become more complex, it is becoming more difficult to address the risks with traditional insurance alone. Economic losses from global natural disasters in 2023 are estimated at $380bn, of which only $118bn was insured. This represents a 69% protection gap, said Cole.

At the same time, insured values continue to increase in the most exposed geographic areas. The frequency and severity of events and corresponding economic loss continues to rise.

Meanwhile, the availability of traditional nat cat capacity continues to be constrained and, when available, the cost of capacity is significantly higher than in the past.

While traditional (re)insurance continues to be an important tool in the nat cat risk management toolbox, new and creative approaches are needed to adequately and fully address the risk, said Mayer.

One of the core benefits of parametric solutions, based on a previously agreed trigger verified by a third party, is, of course, the speed of payment, stressed the speakers.

Another key benefit is the potential broad nature of cover. Payment can be used for any financial loss resulting from an event. Expenses and loss that are typically excluded from traditional insurance coverage can be addressed. There is also no financial deductible.

Vetter explained another benefit is flexibility in design.

“Parametric coverage can be customised to solve specific problem(s) that are difficult for traditional insurance to deal with. This could include (but is not limited to) contingent business interruption, difficult to insure risks, supply chain exposures, and many others,” he said.

The speakers were keen to stress that parametric solutions are not here to replace traditional nat cat cover but supplement what is on offer.

A parametric solution hedges traditional insurance because it settles quickly while traditional is being adjusted, and broad coverage fills in the gaps within a traditional insurance policy, they explained. It can also provide supplemental capacity when programmes are difficult to fill.

Another key attraction is that parametric solutions can address difficult-to-insure or uninsurable risk such as transmission and distribution lines, solar assets, hazardous or exposed occupancies and older structures.

One big area of focus for all risk managers in recent times has been non-damage business interruption (NDBI). Parametric also plays a role here, said Mayer and Vetter.

Due to the broad definition of loss – whereby physical damage at the client’s assets is not required – parametric covers can address financial loss that a client incurs as a result of wide area damage or infrastructure disruption, they said.

Crucially, this can include various types of contingent business interruption loss resulting from damage to key suppliers or customers.

The speakers also stressed that parametric solutions can be used to address new exposures, including employee assistance following a major event, public entity’s loss of tax revenue, and many others.

Our 5th Construction Risk Management Conference (Europe) will take place in London on 23rd & 24th April. This is now the largest gathering of construction project owners, contractors, sub-contractors and insurance markets in Europe. For more information please visit https://events.commercialriskonline.com/CRM-Europe-24