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Education needed for expansion of parametric insurance market

Market participants need more education in parametric insurance solutions to stimulate growth in this space, according to Steve Harry, Managing Director, Marsh Parametric Solutions.

The global parametric insurance market has rapidly developed over the past few years, and is estimated to reach US$34.4 billion by 2033. However, future expansion and growth potential “depends on the perception of the opportunity available”, said Harry at Commercial Risk’s “Global Programmes – Europe 2024” conference, in London, on 18 September.

Harry spoke alongside various experts from the insurance industry during a panel discussion titled, ‘Parametrics, capital markets, and beyond’. The session focused on the development of parametric insurance in response to a hard market, and how this unique solution enables risk managers to ‘hedge’ risk and cover gaps in programmes against perils with increasing likelihood — such as climate change-related extreme weather and natural catastrophe risk.

How parametric insurance differs from traditional insurance

Parametric insurance policies are an innovative, risk transfer solution that can play a vital role in engaging traditional insurance and reinsurance markets with challenging to insure risks — enabling financing for projects difficult to get off the ground.

As parametric policies gain traction, more risk managers are discovering the benefits of placing this form of coverage. The simplicity of cover, with very few exclusions and pre-agreed payout scales in parametric insurance increases transparency and limits misunderstandings — an aspect attractive to clients.

Pay outs for claims made under parametric policies are usually very fast. This can be extremely beneficial for organisations suffering from incidents that require immediate liquidity, such as disruptions to supply chains.

However, it is crucial to view parametric insurance solutions as complementary to traditional insurance policies — rather than a replacement. Risk managers shouldn’t construct global programmes believing traditional insurance and parametric solutions are a binary choice, coverage can be tailored and structured with elements of parametric insurance.

Harry stated that it is also important to be mindful that “parametric insurance is regulated differently in different countries”, with some territories treating it similarly to a derivative.

Parametric insurance within global programmes

Parametric insurance can be useful for risk managers constructing global programmes across multiple industries. Carve outs can be made for specific perils applicable to each, individual territory that multinationals operate in. Earthquake risk in Japan or the threat of hurricanes in the Caribbean are nat cat examples of this.

Under a parametric policy, wind speeds recorded during a cyclone above a certain threshold can trigger a pre-agreed payout. Accordingly, the payout often rises in-line with stipulated increases in wind speed logged. The policy indemnifies against resulting financial loss, regardless of actual damage caused.

For cyber insurance, a company forced into a facility shutdown during a ransomware attack on a cloud provider, would receive a pre-agreed amount for each day of shutdown to cover response and business interruption costs, for example.

As the parametric market expands, it is imperative that education and awareness also grows — especially in relation to how policies are structured alongside traditional insurance products.

Correctly structuring parametric insurance programmes

Parametric programmes require a tailored approach and collaboration between clients, insurers, brokers, data collectors, and relevant regulators.

As parametric insurance is triggered by an index movement, and not by assessing actual damage or loss, risk managers should be aware of basis risk and the potential difference between loss and pay-out. Appropriate structuring of parametric policies is essential for minimising basis risk, and, to achieve this, it is important brokers help make programmes “as bespoke as possible”, said Harry.

Monitoring the index and whether the trigger thresholds/conditions have been reached is often carried out by an independent, third-party data provider — and sometimes a governmental organisation, like the Met Office.

When crafting parametric polices, “indexing does much of the heavy lifting”, stated Harry. It is essential that both the insurer and insured agree on an index that appropriately records and interprets the relevant data, to suitably replicate and represent the exposure for each specific risk. This also ensures the index is defensible in event of claim or no-claim scenarios.

The role of data for parametric insurance

Looking forward, “greater sophistication in the monitoring and quantifying of risk” is also giving potential to parametric growth, added Harry.

Improved techniques and equipment for collecting larger volumes of more accurate data is enabling better indexing for parametric policies. For example, the use of on-site sensors and sophisticated algorithms are two developments increasing the speed and precision of index management, said Harry.

Additionally, the availability of historical data — particularly for risks related to weather patterns — can also enable organisations to ‘back-test’ the structure of a proposed programme to show how a policy would have paid out in previous years.

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