Customization and Flexible Structures Fuel Growth of Parametric Coverages
Damages wrought by the natural catastrophes of 2017 were a wake-up call for companies of every industry. No business should assume it is safe.
Of particular concern is the risk of non-physical damage business interruption, where a facility sustains minimal damage itself, but suffers a lapse in normal operations due to devastation to their immediate area. Loss of infrastructure and loss of attraction can keep customers at bay for significant lengths of time.
Traditional business interruption policies, however, only kick in when the insured entity sustains physical damage. No damage means no coverage.
That’s why companies with significant exposure to non-physical damage business interruption have begun to utilize parametric insurance to supplement traditional policies.
Parametric policies are index-based solutions that trigger a payout as long as an event meets certain severity thresholds, without necessarily requiring the insured asset to sustain physical damage. Thresholds can refer to wind speed, earthquake magnitude, or hurricane category as measured at predetermined locations. If the parameters are met, pre-determined payouts are issued within 30 days; no need for adjusters or a lengthy claims process.
“Once a parametric policy is triggered, the insured simply has to provide a certification of loss that is equal or greater to the payout amount, usually within 12 to 24 months of the event,” said Robert Nusslein, Head Innovative Risk Solutions Americas, Swiss Re Corporate Solutions.
Over the last decade, uptake of parametric policies has grown exponentially, and the growth is not limited to any one industry. Hospitality, energy, public entities, utilities, and health care organizations have all been buying parametric coverage.
“The common theme across these disparate buyers is that they all have an unmet need,” Nusslein said.
“Many companies have very high deductibles for hurricane and earthquake coverage, from 2 to 5 percent of their total insurable value. This amounts to a very large self-insured risk. They have a need for supplemental limit to cover uninsured or underinsured exposures or to fill in deductibles.”
Recent iterations of parametric solutions that allow for more flexibility and customization are driving increased uptake of these policies as supplements to traditional business interruption coverage.
The Evolution of Parametric Solutions
First-generation parametric products debuted more than 20 years ago. Along with triggers set around event intensity, these polices also stipulated a defined geographic region in which the event must occur, usually a radius centered around the insured location.
“These are what we call ‘CAT-in-the-circle’ solutions,” Nusslein said. “They define a geographic area with a center on the latitude and longitude coordinates encompassing the insured assets. A policy trigger would require that the epicenter of an earthquake or eye of a hurricane be within that area.”
The downside of these policies is that they introduce basis risk — the risk that a sustained loss will exceed insurance recovery.
“Let’s say a policy has a payout triggered by a 6.5-magnitude earthquake with an epicenter within a 40-mile radius of the insured location. If a quake occurs within that region but is only a 6.2 in magnitude, or if it is 7.0 in magnitude but the epicenter is 41 miles away from the insured facility, there’s no cover,” Nusslein said. “The insured will likely still have damage but will recoup nothing from that policy. That’s basis risk.”
The second generation of parametric policies eliminates this gap by doing away with defined geographic regions as triggers.
“The coverages evolved to designate certain severity thresholds at specific locations, rather than within a radius. So it would not matter where the epicenter of the quake is as long as the shake intensity meets a certain level at your facility,” he said. “This is much more flexible and nimble and reduces basis risk.”
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.
“What made Hurricane Harvey so devastating was that in addition to being a wind event, it also created storm surge that pushed a lot of water up where the eye made landfall, which was then compounded by several feet of rainfall,” Nusslein said.
That 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 could still trigger the policy.
“Each evolution of parametric coverages has been driven by companies needing a way to better protect themselves from natural catastrophes. As brokers and buyers have become more sophisticated and aware of their exposure, they’ve asked for more customized solutions to meet their needs,” Nusslein said.
Skills and Strength to Address Unmet Needs
While the most common parametric covers address natural catastrophes like earthquakes and hurricanes, there is considerable interest in adapting the policies to respond to non-cat weather events like flooding, fire, snowfall, hail and temperature fluctuations.
Some solutions go beyond weather to focus on industry-specific triggers, like drops in occupancy rates or revenue per available room for hotels, decreased passenger seat miles flown for airlines, or reduced container traffic through a port resulting in tax revenue loss.
“Swiss Re Corporate Solutions is already developing products in these areas,” Nusslein said. “We listen to our broker partners and our clients to really hear what they need, and we have the intellectual curiosity to keep innovating to meet those needs.”
Swiss Re Corporate Solutions’ involvement in parametric structures goes back to their inception roughly 25 years ago, and it has remained dedicated to the space ever since, building a deep bench of atmospheric specialists, seismic specialists, geologists and data scientists.
“Our NAT CAT perils team and our ability to develop our own models around hurricane and seismic activity is second to none,” Nusslein said.
But with speed of payment a primary benefit of parametric insurance, understanding NAT CAT exposure is only half of the equation. Getting funds into the hands of policyholders quickly is where insurers really deliver value. The one-two-three punch of Harvey, Irma and Maria last year would test the mettle of any top-tier carrier.
“It was all-hands-on-deck here to make sure we could deliver on time. We had a number of claims on parametric policies, and we met the 30-day deadline for every one of them. Some payments were delivered in as few as 13 days,” Nusslein said.
“It was a testament not only to the expertise and commitment of our people, but to the strength of Swiss Re’s balance sheet and its reputation for reliability built over our 150 years in the industry.”
To learn more about Swiss Re Corporate Solutions’ parametric solutions, visit https://corporatesolutions.swissre.com/innovative_risk/parametric/.
Insurance products underwritten by Westport Insurance Corporation, Overland Park, Kansas, a member of Swiss Re Corporate Solutions. This article is intended to be used for general informational purposes only and is not to be relied upon or used for any particular purpose. Swiss Re shall not be held responsible in any way for, and specifically disclaims any liability arising out of or in any way connected to, reliance on or use of any of the information contained or referenced in this article. The information contained or referenced in this article is not intended to constitute and should not be considered legal, accounting or professional advice, nor shall it serve as a substitute for the recipient obtaining such advice.
This article was produced by the R&I Brand Studio, a unit of the advertising department of Risk & Insurance, in collaboration with Swiss Re Corporate Solutions. The editorial staff of Risk & Insurance had no role in its preparation.