Parametric cushions the hard market
Trigger happy: parametric cover has many uses, such as protecting mango crops from plummeting temperatures
Suddenly parametric insurance, once regarded as an interesting niche approach to risk, is everywhere. As record losses from floods, bushfires and cyclones turn the stomachs of underwriters and drain capacity in a growing list of markets, parametric solutions are increasingly filling the void.
Everyone from mango and tea growers, shopping centre operators and chemical plant developers – and even insurers trying to minimise their reinsurance load – are now readily taking advantage of parametric cover.
Epsilon Underwriting Agency Chief Underwriting Officer Paul O’Leary tells Insurance News parametric insurers are now heavily exposed throughout Europe, northern Asia and in the United States against windstorm. Meanwhile, the local market is relatively untapped.
“Australia is a good market for this, because it gives capacity providers a good spread of risk,” he says. “They’re not heavily exposed here yet.
“It’s not a product that’s been widely available in Australia for a long period, or even provided by insurance brokers. So the market is largely untapped. It will certainly grow.”
Pioneered by now-fallen US energy giant Enron 26 years ago, parametric insurance is quickly moving from the obscure to hitting its stride as a welcome cushion that softens eye-popping premiums and viability issues.
Parametric cover involves pre-defined payouts based on events that trigger the policy, such as specific rainfall or river level heights for flood cover. Payouts are quick once triggers are met, as there are no loss adjusters and no claims debate.
While traditional insurance promises to cover the actual loss incurred with a goal to put the insured back in the position they were before, parametric insurance is detached from an underlying asset. It is this that makes claim payment faster. Key uses span covering self-insured retention, deductibles, exclusions or hard-to-place risks.
Mr O’Leary says Epsilon was able to help when brokers told him they were unable to get cover in North Queensland. Epsilon’s Paris-based sister company MeteoProtect specialises in parametric solutions and Epsilon has been able to add this capability to its suite of services, and offer a traditional industrial special risks (ISR) policy excluding the cyclone exposure and a parametric solution for the cyclone risk.
“If an insured can get traditional insurance in the market and cover the exposures they’re concerned about, that is by far their best option. But if they are struggling to get cover – and let’s face it, that’s happening more and more – or if they have exorbitant deductibles, then parametric can step in and provide a level of coverage.
“The traditional insurance market is really struggling with catastrophe exposures in Australia and we’re about to go into bushfire season after multiple years of wet seasons resulting in a buildup of bushfire fuel (vegetation). So as more insurers say we don’t want to cover that exposure, clients have been coming to look for parametric solutions.
“It is a broader cover as there are fewer coverage conditions on a parametric policy than on a traditional ISR policy, with no excess, so it covers straight away from the ground up.”
Sydney-based Hillridge Technology Co-founder and Chief Executive Dale Schilling tells Insurance News for any sector exposed to the elements outdoors, parametric needs to be a part of the insurance program. “Think supply chain, construction, events, agriculture of course. They’re the most obvious applications,” he said.
Hillridge has developed a platform that helps farmers buy affordable weather insurance against drought, frost, heat and excessive rain.
“Where no insurance exists today, it can offer a risk transfer product,” Mr Schilling says. “At the moment we’re competing against self-insurance because these risks just aren’t being covered by indemnity-based products. We are also seeing some operators take out parametric insurance to cover their excess.”
For insurers, it offers more simplified underwriting with capped liabilities, and corporate brokers have long organised it at scale for their larger clients.
“This will become much more mainstream,” Marsh Advisory Pacific Head of Alternative Risk Solutions André Kyburz tells Insurance News. “Certainly in the intermediate to larger-size businesses it has already become mainstream, because capacity in the traditional market is just not there anymore.
“It’s exciting and also challenging to come up with the right solution. We are spending a lot of time with our nat cat modellers and we back-test structures against previous events…to make sure that if a similar event happened, the client will get the payout they need.”
Enron – a US energy company which collapsed in 2001 in a massive fraud and corruption scandal – can lay some claim to pioneering “weather payment derivatives” in 1997 with the help of computers crunching official data to use as a measure. US companies could be compensated for, say, a one-degree fall below an agreed temperature.
As parametric cover becomes more common as a risk option, insurance brokers will discover it has some persuasive attractions. Marsh’s commercial pricing index shows one reason for its emergence: traditional insurance terms have notched up 22 straight quarters of premium rises.
“There’s no moral hazard on either the insured or the insurer. It’s simply an index – it’s publicly available data – and if that index is met or exceeded, then the policy pays.” Marsh’s Andre Kyburz
Local property pricing surged 8% in January-March – double the gains of 4% in the previous two quarters – and was up 17% in the US. Global insured losses from natural catastrophes blew out to $US125 billion in 2022, Swiss Re says.
Mr Schilling says Enron’s concept of parametric insurance was born out of the derivatives market for weather during the 1990s for energy utilities. “Now it has broadened out and is going into other sectors, like agriculture and even travel and tourism and the like. It is starting to go mainstream.”
The parametric insurance market is estimated to reach $US29.3 billion by 2031 on an annual compound growth rate of almost 10%.
In its latest market insights report, Aon spotlights parametric as providing rapid liquidity and flexibility, simplifying and improving risk transfer for all parties by drawing a crucial distinction between volatility and uncertainty. Capacity is focused on risks “insurers can understand” – highly volatile fortuitous events backed by data, such as the frequency of a hurricane at a given location.
Parametric “deconstructs traditional risk transfer” by unlocking capacity via an independent event-based trigger, with third-party data sources serving as a proxy for a risk event. When that data responds, the policy is triggered without question, giving the insured quick access to capital.
“While parametric coverages may seem complex as a new solution, the process and outcome for clients is quite simple,” Aon says. “Parametric solutions provide the ‘missing link’ to help grow risk transfer and reduce the protection gap.”
New Zealand’s Tower Insurance has piloted a cyclone parametric insurance product in Fiji, and Epsilon, Redicova and Descartes are examples of underwriting agencies offering parametric cover in the Australian market, along with (re)insurers such as Swiss Re and Axa XL.
Parametric insurance can top up under-deductible losses or operate as an excess-of-loss cover, and sources tell Insurance News insurers are deploying it to manage reinsurance placements.
Innovative uses include developers considering footfall cover for shopping centres, with an agreed percentage fall triggering payment as an alternative to pandemic cover, Marsh says.
In another case, construction of a chemical manufacturing plant in a cyclone zone in Western Australia saw Marsh boost $150 million traditional market capacity with a parametric instrument for a further $250 million. The trigger for the policy was a sustained windspeed greater than 200 kmh.
Parametric can also cover non-damage business interruption, or supply chain problems such as a port being closed.
Marsh’s Mr Kyburz says clients have also turned to parametrics in exasperation with claim settlement processes.
“We’ve seen a lot of that, for example in New Zealand after the 2016 Kaikoura earthquake event – similarly with the flood losses we had in in Australia. There’s just a lot of frustration about the process that you have to go through, and the time it takes until the money flows.
“In many cases, it’s about blending the two, the traditional and the parametric, to give you the best of both worlds.”
He gives the example of a Marsh client who saw their $20 million sub-limit written down to $500,000 at renewal after a flood claim. That’s a case where parametric could fill the gap.
“The pricing might be steep but at least you can buy the cover,” Mr Kyburz says.
Another client waited more than four years for a $300 million earthquake settlement. “The CFO said that maybe $200 million from the parametric market paid within 30 days is the better deal.”
Certainty and quick funds liquidity are enduring long-term benefits, Mr Kyburz says. “It’s not simply for a hard market; I think it will stay. Once people see the benefits and understand the concept, I think they’ll see a lot of good out of it.
“There’s no moral hazard on either the insured or the insurer. It’s simply an index – it’s publicly available data – and if that index is met or exceeded, then the policy pays.”
At Epsilon, Mr O’Leary and Senior Underwriter Ellie Houston say that a good rule of thumb is any weather peril exposure with a loss expectancy less than one in 10 years could likely find an affordable parametric solution.
For example, an insured can elect to only cover cyclones above a category three, and choose the sum insured to help control the cost.
Priced by modelling of historical data, a “truer” price for the risk is generated and can then be tweaked to lower the premium. While they agree it’s “not cheap,” if a client doesn’t have any coverage at all, then it’s a tangible option.
“The beauty of the parametric is that the client can tailor the coverage to their appetite and the coverage they want,” Mr O’Leary says. “Whatever they essentially choose, it can be priced, and then it comes down to affordability.
“If a Lloyd’s market is quoting a $500,000 excess for wind, a parametric policy could be a solution for that.”
At Hillridge, which is underwritten by Mitsui Sumitomo Insurance and Liberty Specialty Markets, the team helped protect a mango grower against unfavourable overnight temperatures, and is finding take-up where a construction project might be delayed by persistent rain.
“If it can be measured, a parametric product can be tailored for it,” Mr Schilling says.
“It’s a sort of snowball effect. Once you launch in one market or you’ve had discussions with one insurer, that then leads to the next opportunity. So it’s a pretty exciting time.”