Parametric insurance: Your fast ally to cover tropical cyclone losses

With global warming, tropical cyclones, also called typhoons or hurricanes, are becoming a more regular occurrence. And as the world’s oceans get warmer, the intensity of these storms is projected to rise.¹ In the United States alone, tropical cyclones have caused nearly USD 1 trillion in damage between 1980 and 2020².

“About 90% of the heat being trapped by global warming goes into the oceans, and that means there’s a lot of fuel in them to fuel tropical cyclones,” noted Martin Hotz, Head Parametric Nat Cat at Swiss Re Corporate Solutions. “In combination with rapid urbanization along the world's coastlines, a tropical cyclone occurring today will cause much more losses than it would have 50 years ago.”

With the threat of damage to economies and livelihoods from tropical cyclones increasing, so has the demand to better mitigate the devastating impact of these storms. Traditional insurance can cover the damages incurred by catastrophic events such as tropical cyclones, yet “a lot of loss remains uninsured,” Hotz said.

In tropical cyclone and other disaster events the protection gap – the difference between actual economic losses incurred and the amount insured – is often still wide. A plethora of potential exposures aren’t recoverable under standard insurance policies, and fall under sub-limits, exclusions or deductibles. For example, the total economic damage stemming from Hurricane Katrina is estimated to be upward of USD 160 billion, but total insured losses amounted to USD 65 billion in 2005 (or USD 86 billion in 2020, accounting for inflation).³

Traditional insurance policies are good at assessing and catering to tangible losses. For instance, roof damage due to a storm will be evaluated after the event, and a claim processed following an actual loss assessment and investigation.

However, there are shortfalls in the sense that damages are not always immediately evident or easily quantifiable. A storm may cause damage to beaches, coral reefs, landscaping, and golf courses, all of which could dent a place’s attractiveness as a tourist destination, Hotz pointed out. The cost of rebuilding can also rise in unanticipated ways as materials and workers tend to be in short supply following a large-scale tropical cyclone. 

Parametric insurance is emerging as a promising solution for just these challenges, addressing the protection gap by picking up losses traditional insurance policies don’t typically cover. In a parametric insurance solution, the policyholder and the insurance company agree on a set of parameters that define the impact of the event. Establishing this standard in advance paves the way for insurers to clearly assess losses and settle claims rapidly - sometimes just days - after a disaster occurs.

By providing predictable and rapid financing, parametric insurance helps policyholders cope with and bounce back from the emergency situations caused by cyclones, instead of struggling to manage the loss assessment and claims process amid devastation.

However, parametric policies also carry a risk in that the payout may not always accurately reflect the severity of an event. Parametric insurance policies for tropical cyclones are typically based on the fundamental paradigm that at a given location, higher wind speeds inflict more losses.

Data can be leveraged in a way that brings the insurer closer to what actually happens on the ground. Emerging technologies can be employed to bring more clarity and certainty to not just preparing for risks such as cyclones, but assessing impact after the fact.

A  proprietary parametric data-based insurance solution developed by Swiss Re specifically for cyclone events, STORM, is a case in point. It leverages data from partner Reask, a climate risk analytics provider, to produce a granular wind speed footprint that makes it much easier to determine a cyclone’s actual severity. STORM can pinpoint the highest wind speed at the policyholder’s location during a tropical cyclone, ensuring the policy pays out based on the intensity of the event as the insured experienced it.

Thomas Loridan, CEO and co-founder of Reask, explained that determining wind speed at a location rapidly is the key. This is simpler around US territories, where detailed observation data is available. However, in places where data is limited to government agency point estimates, widely variable wind speeds in a tropical cyclone make it challenging to deliver an accurate picture of what may happen at a specific location, exposing the insurer to a strong basis risk.

“We use observations where they are available, and we aim to have a solution that behaves just as well in places with patchy observations,” Loridan said.

Harnessing data from a reliable and independent third-party provider is therefore paramount if parametric solutions are to be credible and successful.

“The great thing about using third-party data to support the parametric product is that there’s no subjectivity to it, it’s objective,” explained Stephen Higginson, Head of Customer & Distribution for Australia and New Zealand at Swiss Re Corporate Solutions. “It also means that the potential for the maturity for this kind of product is even greater than it has been in the past.”

Parametric insurance has become more mainstream in recent years and adoption is set to rise further as technology and data resources develop, noted Hotz. “The concept itself is well-tested and proven,” he said. “What’s changed now is that with more and better data, the proposition is more refined and better tested.” Swiss Re Corporate Solutions has settled claims from parametric policies, covering tropical cyclone, earthquake or hail losses, within a few weeks of the event in both 2020 and 2021.

Parametric insurance policies are complementary to, rather than replacements for, traditional insurance programs when it comes to addressing shortfalls in coverage. But together these offer a comprehensive arsenal of protection mechanisms that is much better suited to a world where intangible assets, climate-related risks and volatility are increasing, and the impacts often difficult to predict or evaluate.

^{1 https://www.climate.gov/news-features/understanding-climate/climate-change-probably-increasing-intensity-tropical-cyclones
2 https://coast.noaa.gov/states/fast-facts/hurricane-costs.html
3 https://www.swissre.com/dam/jcr:a835acae-c433-4bdb-96d1-a154dd6b88ea/hurrican-katrina-brochure-usletter-web.pdf}