3 reasons why parametric insurance solutions are more relevant than ever

One of the first significant parametric transactions to be carried out was Parametric Re, arranged by Swiss Re, on behalf of Tokio Marine in 1997. However, despite parametric insurance products having been around for over 20 years they have only really become more popular in the last five years.

So why are more and more organizations starting to look at parametric solutions? Here are three reasons why parametric insurance solutions have moved higher up on the priority list for businesses today.

1. Climate change leading to an increased frequency and severity of weather events

While not limited to weather events, parametric insurance is often associated with providing protection for natural perils, which from a risk management and insurance perspective can create challenges even for those with a sound Business Continuity Plan (BCP) in place.

In recent years, we see the frequency and severity of natural catastrophes increasing. Just looking at the Asian region over the past few months. We have seen Super Typhoon Mangkhut devastating the Philippines and Hong Kong, Japan has suffered from earthquakes, heatwaves, floods and most recently from Typhoon Jebi.

With Mother Nature becoming increasingly unpredictable, awareness and media attention around the increasing risks relating to climate change are at an all-time high and demand for disaster insurance is reaching unprecedented levels. A clear protection gap exists, and according to Sigma, economic losses from disaster events in Asia were an estimated USD 31 billion in 2017, of which only USD 5 billion were covered by insurance. We see companies today beginning to review their insurance cover through a new lens – looking for ways to fill in gaps and complement their existing traditional insurance programs. With the potential of natural catastrophes to cause wide area damage leading to high non damage business interruption (NDBI) losses, parametric insurance solutions are a logical application.

Climate change, while pushing up global temperatures, can also impact extreme events. With Parametric Solutions, clients have peace of mind in view of increasing frequency of extreme events with a tailored and transparent cover that pays out quickly upon the measurement of a pre-defined index or parameter.

So how is this transparency achieved? This brings us to our next point.

2. Improvement in data collection allowing the modelling of previously deemed "uninsurable" risks

When merchants in medieval Italy established the first risk transfer schemes in the form of marine insurance contracts, they did not contemplate that one day insurance forms of the likes of Parametric Solutions would emerge from their early day ways of hedging risk. But how could they? The sheer foundation of what is required to structure a parametric solution was simply non-existent – Data.

As we learned in the article "What is parametric insurance?", parametric insurance requires data reported from an independent 3rd party – often a government agency – that reports objectively about the occurrence of an event such as an earthquake or a tropical cyclone, in a quantifiable way. Without satellites in the sky nor recording stations on land or at sea, this task simply couldn't be met.

Today, however, tremendous advancements in technology have resulted in the availability of reliable high-density networks, which are tirelessly monitoring our planet 24/7. More data than ever is being collected to inform research and emergency planning. With the use of sensor technology, data is even helping clients to mitigate risks before a loss occurs. At the same time, the data from these networks can be used to structure and model new and innovative parametric risk transfer solutions from earthquake intensity covers in Japan to hurricane intensity covers in Puerto Rico.

3. Better data means increased risk assessment certainty and more transparent pricing for clients

Today's widely available, high quality and granular data improves our collective understanding around a wide range of natural perils, on any point on the map. This is good news for any risk manager as the result is better indices which means lower basis risk.

Knowing about natural hazard risk not only allows putting sound business continuity plans in place, it also informs insurance purchasing decisions.  For parametric insurance solutions, pay-out and compensation is dependent on the data that's reported, where the probability of these threshold levels will naturally be reflected in the premiums charged. Compared to traditional indemnity covers, parametric solutions are less susceptible to the vagaries of underwriting cycles as they are assessed based on underlying technical risk. Here, the price is directly related to how likely it is that a certain event occurs, and these likelihoods do not change overnight.

Today, a large amount of that historical data is available for free in the public domain, especially when coming from government agencies. This allows insurers to have an objective and transparent discussion on pricing with clients, who are able to do their own risk assessment and evaluate the proposed parametric structures.

The transparency and quick liquidity that a parametric insurance solution allows, along with the ability to cover otherwise difficult to insure risks, makes it the perfect complement to traditional insurance programs. This is a stark contrast from the simple insurance beginnings in medieval Italy, where if back then a ship did not return from its journey, it would remain a mystery whether it had been sunk by a strong storm – or by a sea monster.

You can find some examples of how Swiss Re Corporate Solutions have structured parametric insurance covers for weather events in our latest publication: