What parametric insurance can do for the construction industry

The construction industry has been at the mercy of the weather since the dawn of time. But the continued increase in extreme weather events as a result of climate change has widened this exposure, threatening to disrupt or delay large-scale projects.

Consequently, construction firms, contractors, developers and business owners are all demanding a new approach to managing, mitigating or transferring this growing risk.

One such approach is parametric insurance – policies that pay out when predefined triggers based on specific weather metrics, such as wind speed, rainfall or temperature, are exceeded. The payout is automatically triggered upon occurrence of pre-agreed factors in line with the indemnity principle but, unlike in a traditional claims handling setup, with no lengthy claims adjustment process to determine the value of the loss.

While traditional policies are still used as the primary means of risk transfer, a growing number of clients are adding parametric-based products to provide extra protection.

There are numerous benefits to such an approach. The combination of traditional indemnity and parametrics-based insurance can bridge gaps in coverage while also providing certainty and swift payouts whenever a claim is made, with no lengthy claims adjustment process to determine the value of a loss.

Parametric insurance is also ideally designed to cater for weather-based risks. An Intergovernmental Panel on Climate Change (IPCC) report from March 2022 states that extreme weather events, such as hurricanes, heatwaves, heavy rainfall and droughts, are likely to become more frequent and intense in many regions.

This is likely to lead to higher insurance costs. A sigma report published by Swiss Re estimates that annual insured losses are likely to double as a result of extreme weather – to an average of more than $100bn, as opposed to $52bn seen during 2012 to 2017. Indeed, the single costliest insurance event of 2022 was Hurricane Ian which incurred estimated insured losses between $50bn and $65bn alone.

Disruptive weather

In Germany and neighbouring countries in western Europe, the threat is not so much earthquakes and tornadoes but spells of extreme weather. For example, temperatures may exceed or fall below the acceptable levels for workers on a construction site, according to regulations, bringing work to a standstill.

Certain weather conditions may be less than ideal for certain building materials. High winds may mean a crane cannot be operated. While the property or site may not be damaged, there could be high costs from the business interruption suffered.

Similarly, there may be supply chain disruption as a result of weather events. For example, prolonged droughts in 2018 and 2022 led to low water levels in the Rhine river, disrupting the supply of materials on what is a crucial European trade route.

In the past, weather was seen as an entrepreneurial risk that many companies were willing to take on themselves. But the increase in extreme weather has led to a change. Construction firms and developers are increasingly wanting to transfer this risk and looking to parametric insurance as an alternative, or complementary, solution to traditional insurance

The advances in data have been crucial in the development of parametric insurance and the ability to create very precise covers and reduce basis risk – the risk of the client suffering a loss but the parametric insurance not being triggered. Tapping new data sources and capturing high quality data at granular levels nowadays allows for far more precise risk views at asset locations.

For other parts of the world, our STORM and QUAKE parametric insurance products are available to meet the needs of customers in the construction industry as well. We customise each parametric policy to closely mirror the insured’s experience during a hurricane or a storm. Following a named event, our data partners produce a granular wind footprint or shake map.

This helps us determine the highest sustained wind speed or ground shake intensity closest to the policyholder’s pre-defined points of interest. The policy pays out based on the intensity of the event as the insured experiences it.

It also pays out for business interruption even if there is no direct physical damage to the site. Furthermore, losses from sublimited or excluded coverage can be recovered using the parametric pay-out.

While there is little we can do to change the weather or prevent earthquakes, we can help ensure it does not become a financial disaster.