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 increase in climate change-induced severe weather events threatens to disrupt and delay large-scale projects and demands a new approach to protecting risk for investors, contractors and owners.

As a result, we have noticed an increase in interest from the construction industry in parametric insurance solutions, which are already widely used across various other industries and geographies. These solutions are attractive because they can bridge gaps in risk coverage and capacity and complement more traditional indemnity insurance while offering a swift and transparent payout.

While traditional policies remain the primary risk transfer instruments, combining them with a parametric-based product provides customers with more peace of mind in the face of new emerging risks and avoids high levels of risk retention.

In 2022, the costliest insurance event was Hurricane Ian, with insured losses estimated at USD 50-65 billion, according to the Swiss Re Institute's sigma report on natural catastrophes. As the Intergovernmental Panel on Climate Change (IPCC) points out in its March 2022 assessment report, extreme weather events, such as hurricanes, heatwaves, heavy rainfall and droughts, are likely to become more frequent and intense in many regions.

Our sigma report estimates that extreme weather is likely to drive annual insured losses to more than USD 100 billion on average from hereon, almost double the average of USD 52 billion between 2012 and 2017.

Construction sites are vulnerable to severe weather and natural catastrophes (NatCat). A storm, flood or earthquake can ground a construction project for a long time and traditional indemnity-based insurance settlements can take months or years to come through. Basing a project in a region prone to NatCat events may mean it will never get off the ground given the trepidation it may cause among investors and insurers.

A construction site doesn’t even have to be directly damaged by a hurricane, flood or earthquake to experience major delays. Supply chain disruptions can also cause them. For example, a severe event in China and India – the world’s biggest cement producers – can impact the construction of a project as far away as Europe or South America.

Another scenario may be workers trapped in a neighboring district affected by a NatCat event. Traditional insurance may cover some of these scenarios.

However, some damages are not indemnifiable under a traditional pure material damage policy such as reputational damage, loss of attractiveness, loss of revenue stream, liquidated damage, cost overruns, change of authority to get permission, loss of license, cost of advertisements, denial of access, unavailability of labor in case of a hurricane, soft factors and so on.

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

This offers a more flexible and customisable insurance approach and can provide cover to risks otherwise not easy to insure. Where traditional insurance primarily focuses on property damage and business interruption resulting from events directly affecting the site, parametric insurance offers a broader scope of coverage.

Payouts are much quicker too – usually within 15-30 days. This enables fast and smooth fund distribution and liquidity to quickly get projects up and running again, reducing any profit loss.

Our STORM and QUAKE parametric insurance products were designed to meet the needs of our 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.

They also pay 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 payout.

Thanks to our parametric insurance, we were able to start two very different projects on opposite sides of the world. What they have in common is they are both located in areas that have experienced earthquakes.

One of our clients is a large US contractor looking to reduce the coverage gap created by a high deductible amount in its traditional insurance policy on a building project in Northern California. The company also wanted to cover uninsured exposures like construction delays, as well as increased material costs and broader area infrastructure damage, among others.

We designed parametric insurance cover for the three-year construction period to mitigate the financial risk from earthquakes at specific locations.

Meanwhile, the Upper Trishuli-1 Hydropower Project located 70km northeast of Kathmandu is one of Nepal's largest foreign direct investments.

It will significantly boost the country’s renewable energy capacity, but the devastating 2015 earthquake and a series of large losses affecting dams across the world made many insurers reluctant to provide earthquake coverage, jeopardizing the financing of this USD 650 million project.

We were able to step in and, in close collaboration with the lead lender IFC and insurance advisor Aon, structure a five-year parametric insurance cover that met the requirements of all stakeholders and enabled the project to progress.

Payouts for both projects are triggered by the shaking intensity at each project site and are based on shakemaps provided by the United States Geological Survey after a major earthquake.

These examples show how parametric insurance – with its ability to fill gaps in traditional insurance coverage, provide quick payouts and total flexibility – can help construction companies face the challenges of climate change and other growing, complex risks.

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.