The rise and rise of parametric insurance

Parametric or index-based insurance is not new. Index-based insurance products have been used as a proxy for incurred loss rather than indemnifying the actual loss for more than two decades.

But for most of that time, parametric insurance appealed to particular segments of insurance buyers, such as energy companies and public sector bodies with a high exposure to natural catastrophes.

The attraction is clear, says Megan Linkin, senior parametric nat cat structurer, Swiss Re Corporate Solutions. “Once you receive the funds, they can be used to address a variety of costs incurred in the aftermath of the event that are uncovered by traditional insurance. For example, the governments need to provide basic needs and services, and will need money to do that.”

The speed of the payout is the critical aspect, says Linkin. “You don’t have to wait for loss adjusters. Data is available almost immediately and in our experience in the last five years, all of our North American claims have been settled within 30 days and typically much earlier than that.”

In the last decade, parametric insurance has become more widely adopted in the commercial insurance market and is now a central feature of alternative risk transfer (ART) offerings.

A significant turning point in the adoption of parametric insurance was in 2017 and the end of the major hurricane “drought” in the United States, says Linkin. The damage wreaked by hurricanes Harvey, Irma and Maria and the consequent losses made many corporates realise the extent of their exposure to natural catastrophes, says Linkin.

“We saw a lot more interest from corporate clients, like the hospitality sector. A lot of them discovered they would not get a payout from a traditional insurance product without physical damage, even under their business interruption policies.”

The 2020 Atlantic hurricane season was another catalyst in the evolution of parametric insurance,” says Linkin. “The 12 landfalling US hurricanes were not the most devastating in terms of property damage because they made landfall in less densely populated areas. But they provided a reminder that these types of extreme weather events were going to happen and are expected to happen with increasing frequency.”

There are other contributing factors. Labour disputes during Covid-19 highlighted the dependency on supply chains and the enormous disruption caused from losing a component in that chain, and with many critical ports in seismically active areas, an earthquake could have ramifications for the global economy.

Continuing maturity
There is also the continuing maturity of the products themselves. Risk managers are by definition a cautious breed, but the fact that these policies had been in the market for well over a decade and had been proven to not only pay out but to pay out on time was hugely persuasive, says Linkin.

There have also been some improvements to the product in those 15 to 20 years. “The first generation of products were quite one-dimensional and very simple. If a hurricane is of a certain level and passes through a certain area, then it pays out. But hurricanes have a two-dimensional impact,” says Linkin.

Swiss Re currently offers four types of parametric insurance – FLOW, STORM, QUAKE and HAIL. These products are more focused on what happens at your site or location and how severely that insured site is impacted.

“For example, with our STORM product, we are agnostic on the strength of the hurricane, as defined by the Saffir-Simpson Category,” says Linkin. “We’re more concerned about what happens at your location. We rolled these products out eight years ago, and now that we have had claims and have paid out on those claims, we understand how to design our products better.”

None of these improvements would have been possible without the advances in data that allow for much more accurate meteorological forecasts and risk assessments. Swiss Re uses a number of national agencies such as the National Hurricane Centre, Australian Bureau of Meteorology and Japan Meteorological Agency, and analytics providers like CoreLogic and Moody’s RMS.

“When we look for a data provider, we consider two aspects – whether the index is comparable to the models that we use to price risk and whether the data providers are independent and credible,” says Linkin.

Despite the growth in adoption of ART, there is still a place for both traditional insurance and parametric insurance in a risk managers’ portfolio, says Linkin. “We see them as complementary. Clients may use parametric insurance for additional capacity or for specific locations or for asset classes that are difficult to cover. For example, an archaeological client with buildings that are hundreds of years old and impossible to value.”

In terms of future development, Swiss Re would like to add a flood product to its parametric insurance offerings, but that poses some challenges because of the nature of floods and the causes, says Linkin. “For example, is it a flash flood or a storm surge or a fluvial flood? Do we need better satellite data, river data and rainfall data?”

The ever-evolving field of Big Data means there’s the potential to see a greater number of non-physical indices related to natural catastrophes, such as flight cancellations or changes in dinner reservations, says Linkin. This would possibly create a clearer link between the cause and economic impact of a natural catastrophe, and help grow the mainstream adoption of parametric insurance.