How can parametric insurance help clients navigate today's environment of uncertainty?
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Shifting market dynamics compounded by the COVID-19 pandemic has created unprecedented amounts of uncertainty for insureds, brokers as well as insurers. Over the past year this has resulted in an acceleration of the ongoing trend of market hardening which is not only translating into higher insurance prices, but also capacity constraints as well as a reduced scope of cover provided by insurers.
What do these developments mean for corporations and how can we help clients navigate through these difficult times?
Increasing risk awareness: taking a second look
The current COVID-19 induced recession is one of the sharpest and deepest on record and has led to budgetary constraints across several sectors. As a result, many companies today have less discretionary spending available for insurance than they might have had in the past. It is unsurprising therefore, that we see more clients re-evaluating their retention strategies and reconsidering what risks they should transfer, retain or self-fund by other means.
We also have observed an overall increase in risk awareness. Many companies were taken by surprise by extent and severity of disruption caused by the pandemic – very often not an exposure that risk managers had on the top of their minds. This has also made corporations more alert towards potential gaps in their current insurance programs. Consequently, an increasing number of companies are looking for solutions in the alternative risk transfer market. And here in particular, we are seeing a rising interest in parametric insurance solutions – a very effective instrument to fill the gaps left by traditional insurance programs. Parametric insurance can be used to source additional capacity, provides payout certainty and liquidity when is it most needed, and offers a solution to protect against pure financial losses, in particular when it comes to "intangible" exposures.
How parametric insurance differs from traditional indemnity based insurance
Parametric insurance is designed, not to replace, but to complement traditional insurance programs.
Conventional insurance is purely indemnity based, compensating the insured for the cost they incur for the repair or replacement for a physical asset that has been damaged. Parametric insurance on the other hand is fundamentally different. It is insuring the probability of a pre-agreed event occurring and therefore purely relies on the measurement of an event or an index – such as the magnitude of an earthquake or the storm category of a typhoon. Once this measurement meets or exceeds an agreed threshold, the policy is triggered and a pre-defined payout is generated.
Because parametric insurance is formulaic and does not involve a complex and protracted loss adjustment process, the insurance payout is very quick and gives the client access to liquidity when it is most needed. This is even more important in situations like the current pandemic where loss investigations are delayed and protracted because of global movement restrictions.
What are the key drivers to consider parametric insurance solutions?
The motivations for parametric insurance can be very varied, and based the fundamental principles of the concept, we see parametric solutions adding value in the range of scenarios:
What are the most common applications of parametric insurance solutions today?
With global warming increasing both the severity and frequency of extreme weather events, unsurprisingly, the most prominent application of parametric insurance remains in the area of Natural Catastrophes (Nat Cat) and extreme weather. Asia Pacific (APAC), as the fastest-growing region globally in terms of economic growth and urbanisation, is particularly vulnerable to the impact of climate change. The region was hit by 108 natural catastrophes in 2019 and these events accounted for US$66.4 billion in economic losses — the highest of any region (Swiss Re Institute).
And of these economic losses only 30% were actually insured, leaving a very significant protection gap in the region. So by far the most interest in parametric insurance in APAC is still for the classic NatCat events like Typhoon /Cyclone, Earthquake and Flood/Drought. As payout is made upon the occurrence of a triggering event, it is detached of an underlying physical asset or piece of infrastructure. As such, parametric solutions can cover part of these economic losses and are ideal to fill existing insurance gaps.
Parametric insurance however is not only for extreme events. We increasingly see interest in covers for inclement or adverse weather. Examples could be protecting against too many rainy days, too many windy days, too many hot days or even, too many hazy days – all which can have a painful impact on businesses and profits depending on which sector companies are trading in. Prolonged rain season or heat waves can delay construction projects and cause over-runs, penalties and additional labor costs. An unexpectedly mild winter can cut your profits if you're an energy provider. Too little snow can reduce tourist revenues and increase the cost of snowmaking if you own a ski resort.
On the flip side, parametric insurance can also be used to cover resource risk, and insure for shortfall if, for example, there is not enough wind or sun. For renewable energy providers, too few windy or sunny days could impact production and resulting profits. Insuring such a shortfall via a parametric or index-based insurance can help these clients steady their income stream.
Finally, over the past couple of years, we also have seen an increased interest in non-weather related indices to cover for potential "black swan events" – We have worked with clients to structure solutions for loss of attraction of a tourism spot caused by terrorism or travel disruptions, using hotel occupancy rates or flight delays as trigger, With globalization and ever more complex supply chains we also see increasing interest in protecting against supply chain disruptions triggered for example by the insolvency of a key supplier or loss of license of a key supplier.
This will ultimately lead to new and more efficient solutions, ultimately helping to close the protection gap.
With an accelerating trend of market hardening, rates increasing, terms tightening and capacity reducing, parametric insurance solutions can help companies to navigate these uncertain times and should be part in the overall considerations when putting together a holistic risk management strategy. We are happy to work with our clients to explore such alternative risk transfer solutions complementing their conventional insurance programs, with the aim to providing longer term certainty and reducing the protection gaps.