Coverage Spotlight: Parametrics

8 Questions for Robert Nusslein

After a Nat Cat, traditional insurance can fall short in its timeliness and breadth of coverage. An industry exec discusses an alternative.
By: | April 9, 2018 • 7 min read

As hurricanes, earthquakes and wildfires appear to grow more frequent, more intense, and more widespread, a clear need has developed for insurance products that can provide rapid claims payments and address business needs such as business interruption. One such product is parametric insurance. In this Q&A, Swiss Re Corporate Solutions’ Head Innovative Risk Solutions Americas, Robert Nusslein shares how these structures address gaps in traditional solutions.

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R&I: What is Parametric insurance?

Robert Nusslein: Parametric policies are index-based solutions that trigger a payout as long as an event meets or exceeds certain pre-defined event parameters. These can include severity thresholds like wind speed exceedance, hurricane category, or earthquake shake intensity, as measured at specific locations where the insured has covered assets.

If the parameters are met, pre-determined payouts are typically issued within 30 days. The insured just has to provide a certification of loss stating that the loss was equal or greater to the payout amount, typically within 12 to 24 months.

R&I: What are the key differences from traditional insurance?

RN: Traditional insurance is indemnity based, and coverage is based on the policy terms and conditions such as deductibles, exclusions, limits and sub-limits. Claims are paid when losses exceed the retention held by the insured.

Parametric insurance is index-based, meaning coverage is triggered if pre-defined event parameters are met or exceeded. The payout amount is predetermined. There’s no claim adjustment process to determine the value of the loss. The parametric trigger is set in a manner that if it is triggered, it is highly likely the insured sustained actual loss. If the policy is triggered, you get paid in 30 days or less. It’s that simple. There is no dollar-based deductible or retention.

If the policy is triggered, you get paid in 30 days or less. It’s that simple.

Of course, individual transactions can have different or additional terms and conditions, depending on the unique needs of specific insureds, but this is a basic contrast between traditional insurance and parametric insurance.

R&I: What are the pros and cons of parametric coverage?

RN: The most significant and impactful benefit may be the speed of payment. Quick liquidity is critical in the aftermath of a natural disaster because it gives insureds the funds they need to begin recovery as soon as possible.

Parametric products can also fill in coverage gaps left by traditional policies. Non-physical damage business interruption is one example. Traditional insurance requires business interruption to stem directly from physical damage to an insured property. But it’s not uncommon for a facility to emerge unscathed from a natural catastrophe, while the surrounding area is badly damaged or inaccessible. There will still be losses from business interruption, but a traditional policy won’t cover it.

Payouts from parametric policies can be applied however the insured chooses, covering direct and indirect loss and any expenses associated with the event. Coverage for business interruption does not require physical damage to insured assets.

One potential downside of a parametric Nat Cat cover is basis risk. Basis risk is the difference between an insured’s loss and the parametric insurance recovery. Basis risk is present in traditional insurance policies as well in the form of deductibles or retentions, exclusions, sub-limits and unresponsive cover, such as business interruption losses must result from physical damage to insured assets not just arising from the event.

R&I: Can you expand on basis risk in parametric insurance?

RN: Basis risk was more prevalent in first generation Cat-in-the-Circle (“CIC”) or Cat-in-the-Box (“CIB”) parametric insurance products. There was a near miss factor whereby the event occurred outside of the pre-agreed geographic area or below the coverage trigger attachment point.

For example, a first generation CIC parametric policy could have the following triggers: One hundred percent of limit payout if the epicenter of a 6.5 or greater magnitude earthquake occurs within a 40-mile radius of the insured location. What if the epicenter occurs within that region but is only a 6.2 magnitude event? Or what if the magnitude is 7.0, but the epicenter is 41 miles away from the specific location?

The insured is likely going to have damage, but will recoup nothing from that policy because it just missed those triggers. That’s basis risk.

It’s not uncommon for a facility to emerge unscathed from a natural catastrophe, while the surrounding area is badly damaged or inaccessible. There will still be losses from business interruption, but a traditional policy won’t cover it.

R&I: How have these products evolved?

RN: Second generation parametric insurance products did away with geographic regions as triggers. Instead, parameters are set around reported event severity at specific locations, rather than within a pre-agreed area. So it would not matter where the epicenter of the quake is as long as the shake intensity meets a certain pre-agreed level at your facility. The same is true for hurricanes. Wind speed exceedance thresholds are set at each of the insured’s locations. Shake intensity of an earthquake or wind speeds reported at your facilities is a much better proxy for physical damage and business interruption. This is a much more flexible and nimble cover and reduces basis risk. Broker and buyer interest has skyrocketed after these innovations.

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The third generation of parametric structures allows even more flexibility by creating “either/or” triggers — a design driven by the convergence of multiple factors of wind, rain and storm surge that make hurricanes so damaging.

Hurricane Harvey, for example, was a wind event and a significant rain event that also created a significant storm surge. All three of these contributed to massive flooding. Harvey drove exploration into the possibility of having custom triggers for each one of those factors, so even if wind speeds didn’t meet the designated threshold, a significant storm surge or excess rainfall could still trigger the policy.

R&I: Who are parametric policies most useful for?

RN: Really any corporation or public entity with natural catastrophe risk can supplement its traditional property insurance. Many large corporations have very high deductibles for hurricane and earthquake coverage, from 2 to 5 percent of their total insurable value, uncapped. This amounts to a very large self-insured risk. They also have a need for supplemental limits to cover uninsured or underinsured exposures, such as service interruption, extra expense or to fill in those high percent deductibles.

Parametric covers can fill in those gaps. In this way, it works best as a supplement to traditional insurance, not a replacement for it.

Many industries are buyers of parametric insurance and include manufacturing, hotel/hospitality, real estate, construction projects, public entities, energy, and utilities specifically for uninsured T&D line exposure. Public entities also have a need for quick disaster/emergency response funds, but emergency response funds unrelated to physical damage are usually excluded or take significant time for traditional insurance to respond to. Parametric earthquake and hurricane covers meet this need.

Hospitality companies with coastal properties which are hurricane-exposed can also benefit from a supplemental parametric policy, as they stand to lose significant revenue from business interruption unrelated to physical damage which is excluded from traditional insurance policies, following a Nat Cat. Area-wide devastation can result in a loss of attraction resulting in lower occupancy rates for an extended period and lost income.

R&I: What is the take-up like?

RN: After the 2017 hurricane season with Harvey, Irma, and Maria, we are seeing a massive rise in parametric hurricane insurance inquiries. 2017 was Swiss Re Corporate Solutions’ most productive year with around 50 closed parametric Nat Cat deals globally. Transactions are split roughly 50/50 between earthquake and hurricane risk. Hospitality, onshore and offshore energy, real estate, public entities and manufacturing companies have all shown interest.

The third generation of parametric structures allows even more flexibility by creating “either/or” triggers — a design driven by the convergence of multiple factors of wind, rain and storm surge that make hurricanes so damaging.

However, corporate transactions have been on the rise over the past 10 years. This is due in part to the evolution of parametric structures that have allowed more flexibility in designing policy triggers to cover a broader scope of risk. Both modelling firms, like RMS, and insurers have made great strides in their ability to model and price frequency and severity of Nat Cat events.

R&I: What else can a parametric structure be applied to?

RN: The most common parametric covers address natural catastrophes like earthquakes and hurricanes because there is good historical data, robust modelling and an ability to settle claims based on independent, third-party Nat Cat indices. But there is considerable interest in adapting the policies further to respond to other weather events like flooding, wild fire, snowfall, hail, excess rainfall, and tornado and temperature fluctuations.

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Storm surge is the next development that we are working on right now. The ability to provide a parametric storm surge cover depends on reliable time series data, the presence of reliable tidal surge gauges, the ability to model the risk reliably and access to an independent index to settle claims post event.

But parametric insurance could also go beyond weather events. We’re focusing on industry-specific losses resulting from catastrophic events. Some unique triggers could include: reduced passenger seat miles flown for airlines, reduced occupancy rates or revenue per available room for hotels, reduced flight arrivals into a tourist destination for a variety of potential industries, reduced container traffic through a port and resulting tax revenue loss for the municipality operating the port, and reduced foot traffic through a retail center from a variety of events, which may include Nat Cats and others such as terrorism.

We are already developing solutions to meet these needs. &

Katie Dwyer is an associate editor at Risk & Insurance®. She can be reached at [email protected]

More from Risk & Insurance

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The Profession

For This Pharmaceutical Risk Director, Managing Risk Means Being Part of the Mission to Save Lives

Meet Eric Dobkin, director, insurance and risk management, for Merck & Co. Inc.
By: | September 28, 2018 • 5 min read

R&I: What was your first job?
My first job out of undergrad was as an actuarial trainee at Chubb.I was a math major in school, and I think the options for a math major coming out are either a teacher or an actuary, right? Anyway, I was really happy when the opportunity at Chubb presented itself. Fantastic company. I learned a lot there.

R&I: How did you come to work in risk management?
After I went back to get my MBA, I decided I wanted to work in corporate finance. When I was interviewing, one of the opportunities was with Merck. I really liked their mission, and things worked out. Given my background, they thought a good starting job would be in Merck’s risk management group. I started there, rotated through other areas within Merck finance but ultimately came back to the Insurance & Risk Management group. I guess I’m just one of those people who enjoy this type of work.

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R&I: What is risk management doing right?
I think the community is doing a good job of promoting education, sharing ideas and advancing knowledge. Opportunities like this help make us all better business partners. We can take these ideas and translate them into actionable solutions to help our companies.

R&I: What could the risk management community be doing a better job of?
I think we have made good advancements in articulating the value proposition of investing in risk management, but much more can be done. Sometimes there is such a focus on delivering immediate value, such as cost savings, that risk management does not get appropriate attention (until something happens). We need to develop better tools that can reinforce that risk management is value-creating and good for operational efficiency, customers and shareholders.

R&I: What’s been the biggest change in the risk management and insurance industry since you’ve been in it?
I’d actually say there hasn’t been as much change as I would have hoped. I think the industry speaks about innovation more often than it does it. To be fair, at Merck we do have key partners that are innovators, but some in the industry are less enthusiastic to consider new approaches. I think there is a real need to find new and relevant solutions for large, complex risks.

R&I: What emerging commercial risk most concerns you?
Cyber risk. While it’s not emerging anymore, it’s evolving, dynamic and deserves the attention it gets. Merck was an early adopter of risk transfer solutions for cyber risk, and we continue to see insurance as an important component of the overall cyber risk management framework. From my perspective, this risk, more than any other, demands continuous forward-thinking to ensure we evolve solutions.

R&I: What’s the biggest challenge you’ve faced in your career?
Sticking with the cyber theme, I’d say navigating through a cyber incident is right up there. In June 2017, Merck experienced a network cyber attack that led to a disruption of its worldwide operations, including manufacturing, research and sales. It was a very challenging environment. And managing the insurance claim that resulted has been extremely complex. But at the same time, I have learned a tremendous amount in terms of how to think about the risk, enterprise resiliency and how to manage through a cyber incident.

R&I: What advice might you give to students or other aspiring risk managers?
Have strong intellectual curiosity. Always be willing to listen and learn. Ask “why?” We deal with a lot of ambiguity in our business, and the more you seek to understand, the better you will be able to apply those learnings toward developing solutions that meet the evolving risk landscape and needs of the business.

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R&I: What role does technology play in your company’s approach to risk management?
We’re continuing to look for ways to apply technology. For example, being able to extract and leverage data that resides in our systems to evaluate risk, drive efficiencies and make things like property-value reporting easier. We’re also looking to utilize data visualization tools to help gain insights into our risks.

R&I: What are your goals for the next five to 10 years of your career?
I think, at this time, I would like to continue to learn and grow in the type of work I do and broaden my scope of responsibilities. There are many opportunities to deliver value. I want to continue to focus on becoming a stronger business partner and help enable growth.

R&I: What is your favorite book or movie?
I’d say right now Star Wars is top on my list. It has been magical re-watching and re-living the series I watched as a kid through the eyes of my children.

R&I: What is the riskiest activity you ever engaged in? When I was about 15, I went to a New York Rangers versus Philadelphia Flyers game at the Philadelphia Spectrum. I wore my Rangers jersey. I would not do that again.

Eric Dobkin, director, insurance & risk management, Merck & Co. Inc

R&I: What is it about this work you find most fulfilling or rewarding?
I am passionate about Merck’s mission of saving and improving lives. “Inventing for Life” is Merck’s tagline. It’s funny, but most people don’t associate “inventing” with medicine. But Merck has been inventing medicines and vaccines for many of the world’s most challenging diseases for a long time. It’s amazing to think the products we make can help people fight terrible diseases like cancer. Whatever little bit I can do to help advance that mission is very fulfilling and rewarding.

R&I: What do your friends and family think you do?
Ha! My kids think I make medicine. I guess they think that because I work for Merck. I suppose if even in a small way I can contribute to Merck’s mission of saving and improving lives, I am good with that. &




Katie Dwyer is an associate editor at Risk & Insurance®. She can be reached at [email protected]