As the hard insurance market continues, and risk budgets remain constrained, many organizations are having heightened difficulty filling their coverage towers, leaving potentially problematic protection gaps and forcing many risk managers to retain more risk.
Parametric insurance is increasingly helping buyers rethink their access to capital by providing a complementary risk solution to their traditional program with additional resiliency and capacity, especially for natural catastrophe black swan events, which can include earthquakes, wildfires, named windstorms, etc. Parametric insurance is a potential risk solution for any weather event that can be independently indexed by a third party.
Beyond natural catastrophe events, parametric insurance is also well-suited for other exogenous events and non-damage business interruption. By using data that is verifiable, transparent and consistent, insurers can underwrite parametric policies that address events such as drops in tourism volumes, supply chain disruptions, and pandemics, all situations where there is an impact from the events regardless of any physical damage to the insured.
How does parametric insurance work?
Parametric insurance is an innovative, straight-forward solution that can serve as a powerful risk management problem-solving tool:
- Parametric policies pay out when a triggering event occurs, as validated by an independent third party, without the need for a claims adjuster. In the absence of a dispute, organizations often receive parametric benefits quickly. Payouts are triggered by indexed event severity.
- Payout structure is pre-negotiated and formulaic, determined before the policy is issued.
- Coverage is generally broad – typically any economic interest arising from an event. Uninsurable exposures become insurable.
Parametric solutions can provide value in three ways:
- It is ground-up coverage, and as long as the event triggers policy parameters, coverage is available and can be used in the tower as a tail-risk deductible in-fill.
- For risk managers having difficulty filling tower capacity in the current hard market, parametric insurance can be a source of additional excess capacity.
- Coverage for non-traditional exposures tied to an event are self-retained or self-insured without parametric insurance. Parametric insurance provides the capital to cover these exposures and enhance resiliency.
How it makes sense as a solution for natural catastrophes
Parametric insurance helps organizations match insurance capital to their specific risk profiles, providing more liquidity exactly with events that will have the most risk impact, such as natural catastrophe events. Risk managers who understand their total cost of risk can use parametric insurance to complement their traditional indemnity programs, providing additional capacity for natural catastrophe exposures.
While parametric insurance may be more expensive than traditional coverage, the solution can lower the total cost of risk if used wisely. As an example, adding parametric capacity may allow an organization to be more comfortable with a higher retention on additional traditional indemnity risk for hurricane, which could fund the cost of the parametric solution. With a parametric solution, less non-traditional risk is retained, ideally freeing up capital for other uses and lowering the cost of risk.
But beyond the impact on cost of risk, parametric insurance provides an important strategic tool where organizations can partner with insurers to solve additional complex business problems. Many exogenous, non-damage business interruption events, such as COVID-19, are not readily addressed by existing insurance solutions. As the industry collectively works to better enhance resiliency to these events and other emerging risks, parametric insurance can be a key tool to better match capital to risk.
How parametric insurance helps mitigate earthquake risk
Corporate campus is located in an earthquake exposure area and has a mix of controllable factors (engineering and construction of owned physical assets) and uncontrollable factors (resiliency of employees, customers, other stakeholders in the community impacted by potential loss). Example outlines an earthquake risk, but any natural catastrophe exposure could also apply.
- “Earthquake drought” and lack of societal readiness augments the uncontrollable factors.
- Challenges with traditional insurance, including inherent coverage limitations, timing mismatch of payments vs. when problem being managed, and hard market.
Challenge: Trigger Design
- How to best design the parametric insurance triggers that correlate to broker expectations of event exposures.
- Balance simplicity and complexity while maintaining value proposition of the coverage.
Designing the Parametric Solution:
Step One: As this is geographically based coverage, the first step is to correlate the parametric solution’s response to the exposure by defining key geographical areas of concern on the campus and community – areas that would be most impacted by an earthquake. Trigger locations associated with these areas are then set and become the building blocks for the parametric solution.
Step two: Once measurement points are established, limits are distributed among each of the points in proportion to the level of economic activity. A payout table is then established. For each trigger location a pre-agreed payout matrix is created based on intensity of exposure. The intensity of an earthquake will drive payout level, and is based on metrics provided by the USGS, an independent third party.
Evaluating the Solution:
The solution can be tested based on past events or scenarios, including hypothetical USGS “shake map” case study. For each trigger location, the earthquake intensity data would be assessed. The intensity of the earthquake drives a percentage payout, which is applied to each trigger’s pre-determined limit.