Parametric solutions key to weathering risk

David Price, Director of Specialty, explains the fundamentals behind parametric insurance solutions and why the industry is well positioned to leverage their potential

Product innovation and data analytics have expanded the scope of commercial insurance solutions to offer better and more sophisticated coverage for a wider range of threats, exposures and perils.

Parametric, or index-based insurance solutions, are completely different from traditional insurance and a great example of developing innovation we are seeing in the industry.

These can be used where there isn’t any traditional coverage available or where it is very expensive.

What is parametric insurance? 

Parametric risk transfer solutions are, as the name suggests, coverage or protection based on certain parameters. Typically a parametric cover is constructed of the following:

  1. A trigger event – a predefined objective parameter; this could include anything where there is the appropriate level of data. Some examples are earthquake, wind speed, precipitation, the size of hail and, coming soon, reputational harm using social media data.
  2. A payout or limit – an approximation of the loss that may be incurred if such event was triggered.

Where the contract parameters are met the contract is deemed as fulfilled and a predetermined “pay out” is made, there is no indemnification for the loss. We typically see parametric solutions being used in weather-related risk transfer, hence the rise of popularity for so called catastrophe bonds.

One of the most obvious differentiating factors between traditional insurance and parametric solutions is when it comes to loss adjustment and claims handling. The payout is binary – if the trigger is met, the full limit is paid; if the trigger is not met, no payment is made.
The threshold for that pay-out is usually set in such way that aligns with a client’s own business continuity plan and risk tolerance which means where the structure may include standard products and policy wordings, each parametric insurance solution will be personalised and bespoke.

What’s behind parametric popularity?

Despite parametric insurance products having been around for over 20 years, they have become more popular in the last five years. Cost implications and increase of frequency of weather based events have led insurers to looking at Cat Bond alternatives which have also become of interest to clients searching for their own insurance solutions.

Technology advancements have made sophisticated actuarial modelling available for previously deemed ‘uninsurable’ risks, whereas better data means increased risk assessment certainty and more transparent pricing for clients.

Impact of climate change

Natural climate change is also playing a part. With an increased frequency and severity of weather events and awareness of the risks relating to climate change at an all-time high, demand for disaster insurance is reaching unprecedented levels.

Parametric insurance solutions can facilitate risk transfer solutions that are simply not possible with conventional insurance products, and broaden the scope of the insurance on offer to help communities rebuild after an extreme event.

We have been providing parametric solutions for a range of client demands e.g. snow budgets, hail coverage for car dealerships, flood coverage for golf courses, windstorm coverage for transmission and distribution lines and buying downwind deductibles to zero, crop yield – protecting crops from frost – and wildfires. The list is endless, subject to data being available to evaluate the chances of a loss to the defined trigger(s).

The role of the broker in our changing market place is to be proactive. We are constantly identifying new risks and uncovered areas of exposure and working closely with Underwriters to create the new and innovative products to meet our clients’ demands.