The role of parametrics in mitigating climate risk

ESG Risk Review talked to Stephen Lathrope, senior vice-president, ICEYE, and Alex Korb, head of parametric insurance, ICEYE, about the role of parametric solutions in mitigating climate risks, and how captives can play a role.

With parametric solutions being talked about for climate risks, is the captive a useful vehicle for such solutions?

Stephen Lathrope: There has been a clear uptick in interest in and adoption of parametric-based insurance solutions by the corporate sector. The advantages of such products, including speed of payment relative to indemnity cover, flexibility of structure, level of transparency, and scope of potential coverage, make them a highly attractive business proposition.

As a result, parametric covers have been used by a wide spectrum of industries for a number of years – particularly those sectors with significant property and non-damage business interruption exposures to natural catastrophes. These include hospitality companies, real-estate management firms, transportation bodies, off and onshore energy companies.

And the appeal of parametric structures is being recognised in more and more arenas. For example, ICEYE is involved in multiple discussions with companies in sectors including pharmaceuticals, renewable energy and banking regarding such solutions.

Another area that has seen significant parametric traction is the public sector. ICEYE is working on several flood resilience-focused initiatives with governments and institutions such as the United Nations Development Programme (UNDP), supporting parametric-based structures to provide financial support to vulnerable communities in flood-exposed regions in Ghana and Nigeria. We have also been involved in a similar parametric-based flood project with The Center for New York City Neighbourhoods and the NYC Mayor’s Office of Climate & Environmental Justice to provide rapid cash payments to low-and-middle-income communities in the event of a significant flood.

Can parametric solutions cover non-property risks? Can you give some examples?

Alex Korb: Absolutely – and this is clearly an expanding area of interest given the potential afforded by parametric structures to provide protection for non-physical-damage-related covers that typically fall outside of a standard indemnity insurance product.

Let’s take one example of a major resort in a cat-exposed region. If a hurricane occurs with no direct physical damage to the resort but significant damage across the region, this is likely to result in significant business disruption and loss of attraction losses. Parametric structures are particularly effective at offering a speedy solution to these non-physical-damage-related impacts.

Another example was the use of a parametric catastrophe bond structure established by the World Bank in 2017 for pandemics. This was triggered during the Covid-19 pandemic, with the trigger threshold based on independent data from the World Health Organisation relating to reported deaths and cases in the areas covered.

Stephen Lathrope: This is an important point. Every parametric structure requires an independent reporting authority that supplies the data or index that confirms whether the structure has been triggered or not. ICEYE’s role in parametric solutions for floods, wildfires and other perils is to function as that independent reporting agency, providing data on flood extent and/or depth or other event metrics in the immediate aftermath of an event for such parametric transactions that leverage ICEYE data.

Increases in the availability of data and advances in technology are creating the potential for huge forward strides in the application of parametric solutions across much broader exposures. For example, in response to the global increase in the frequency and severity of wildfire events, ICEYE has developed a data solution that enables users to assess building damage within the burn area in near real-time.

With parametric solutions being talked about for climate risks, is the captive a useful vehicle for such solutions?

Stephen Lathrope: In many ways, parametric solutions and captive vehicles are an ideal partnership. Captives are designed to be flexible – in fact many of the innovative products that are now more commonplace in the insurance market can trace their origins to captive structures as they have provided the vehicle for corporates to self-insure for risks where products were not readily available in the standard market.

Climate risk is clearly becoming an increasingly prominent exposure for many organisations. Captives are now an integral part of the risk transfer strategies of numerous companies – in fact, more than 90% of the Fortune 500 companies currently have at least one captive subsidiary. Therefore it is no surprise that we have seen a marked increase in the use of such structures as vehicles for parametric solutions to address these climate exposures.

It is also worth noting that in June, Apollo launched the first captive syndicate at Lloyd’s, a market renowned for its innovative approach to risk. With expectations of a strong captive market pipeline, it is likely this will stimulate further usage of such vehicles for climate risks.

As mentioned, such a solution is particularly effective for addressing key non-physical-damage-related losses resulting from the increase in frequency and severity of natural perils, where there might be a lack of relevant indemnity cover in the traditional market.

How do parametric solutions work with captives?

Alex Korb: Captives could serve as vehicles for various parametric solutions. There are a number of ways in which this can operate – for example, the captive can either provide cover directly to the parent on a parametric basis or provide indemnity cover while using a parametric solution to cede to the reinsurance sector.

Once again, it is important to note that a requirement of the parametric trigger is that there is an independent third-party reporting agent that provides the data, upon which the decision is made as to whether the structure has been triggered.

Also, advances in the ways in which data can be captured and verified are enabling the creation of much more precise parametric triggers. In the case of flood-related events, ICEYE’s ability to combine satellite imagery with auxiliary ground-level information such as elevation models, ground sensors and river gauges, is enabling new levels of resolution, both in terms of accurately measuring flood extent and the depth at the building level.

Are parametric solutions appropriate for a range of size of risk, or only for large risks?

Alex Korb: The flexibility of parametric-based structures means they can be used across a wide range of risk sizes. At the corporate level, this could range from hundreds of thousands of dollars through to hundreds of millions.

It is important to also recognise that such solutions are highly scalable. In the case of the New York City transaction we mentioned, while this project is designed to support a number of low- and moderate-income communities in high-flood-risk neighbourhoods in NYC, it could equally serve the needs of cities, states, countries and entire regions.

Stephen Lathrope: As an increasingly strategic component of the risk financing capabilities of organisations, captives can play a significant role in supporting ESG objectives and requirements, particularly given the rapidly expanding regulatory focus on this area.

The inherent flexibility of the captive, coupled with the ability to create very bespoke covers including specific transaction payouts or activation thresholds afforded by parametric solutions, makes that combination particularly valuable given the expanding scope of ESG-related challenges that companies face and the need for innovative responses.

Examples of such uses can include the creation of targeted coverage specific to the unique environmental exposures faced by a particular organisation to reduce the financial impact of such losses and improve resilience. Another example is the development of employee-focused benefit coverage to enable cash payments to those impacted by climate-related events disrupting their lives.

A pioneering solution by Swiss Re – the Women’s Climate Shock and Insurance and Livelihoods Initiative – which is a parametric loss of income insurance, was triggered recently, resulting in payouts to thousands of women in India due to extreme heat that prevented them from working.

Such solutions show what is possible and how innovative solutions can be created to address specific ESG-related issues.

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