Why Every Company Should Have a Parametric Policy
According to the World Bank, the earthquake that shook Turkey back in February caused direct physical damage worth $34 billion.
The Turkish Enterprise and Business Confederation, however, estimates the quake’s total economic impact will reach roughly $84.1 billion, including loss of productivity and national income.
“Earthquakes can have a devastating impact, not only on the built environment but on the long-term economic recovery of an area. The aftermath can last months, if not years,” said Megan Linkin, Swiss Re’s senior parametric Nat CAT structurer for North America.
The Turkey quake demonstrates just how far-reaching the effects of natural disasters can be in a global economy.
Because of potential disruptions to manufacturing, shipping and other commercial activities, even entities thousands of miles away are not safe from an earthquake’s damage to their bottom lines.
“Look at the Pacific Northwest and British Columbia, where we haven’t seen a major earthquake strike since the 1700s. Today, they are home to the commercial hubs of Portland, Seattle and Vancouver,” Linkin said.
“Another example would be New Madrid, which hasn’t seen a quake since the early 1800s; that region encompasses Memphis, which is a major hub for UPS. If these hubs of commerce were destroyed or made inaccessible by an earthquake, every link in the supply chain would feel the tremor, and their infrastructure has not been tested by an earthquake in some time.”
The increasing interconnectedness of risk combined with unpredictability of natural disasters means that coverage gaps between traditional insurance policies are inevitable when catastrophes do strike.
This is where parametric solutions come into play, offering three key benefits.
Parametric insurance uses the characteristics of the underlying event that caused the loss to determine the proceeds that are due, instead of using the actual loss incurred.
An earthquake, for example, would have to meet magnitude and location criterion as defined by the policy to trigger a payout, regardless of whether it caused any physical damage to the insured’s property.
“We use site specific ground shaking as reported by the USGS or another independent seismic agency that produces ground-shaking maps at the insured location,” said Swiss Re’s Youssef Baki, parametric structurer for North America.
The objectivity of seismic data and geometric coordinates makes the settlement process extremely transparent. Because the payout is not tied to the loss, there is no loss adjusting process.
If the criteria are met, an event report is generated, and a payment is sent. There is little room for disputing policy terms.
Transparent policies and elimination of loss adjustment beget speedy claim payments.
“For all of our parametric policies in North America, whether for earthquake, hurricane or hail, every single claim has been paid in less than 30 days,” Baki said.
Faster payments mean companies can rebuild faster, minimize business interruption and resume normal operations as quickly as possible, avoiding the stress of a protracted claim adjusting process.
Because payments are not tied to loss amounts, they can be applied in almost any way that helps an insured get back on their feet.
Funds may go toward repairing physical damage, but they could also be used to backfill a high deductible or fill in holes in the balance sheet while operations are disrupted.
The covered assets also do not necessarily have to be where the insured is located. The insured simply needs to demonstrate a vested financial interest in the asset.
“A client may, for example, utilize a warehouse to store goods as they arrive into the port of Los Angeles. They don’t own the warehouse, but if a quake were to damage that structure, the company will have to re-route its goods, which will likely get caught in a backlog as everyone else has to re-route their shipments too,” Baki said.
“That client can define a location in their parametric policy that encompasses that warehouse, even though it isn’t their asset, so that any event affecting that property gives them a payout. The client can then use those funds to address supply chain disruption.”
Who Benefits Most from Parametric Policies?
Swiss Re has been in the parametric space for just over 20 years and has seen applications of parametric insurance expand and interest from all sectors of the economy grow.
Initially, the primary buyers of parametric products were public entities.
“Governments were interested because they were sort of the insurers of last resort and the first responders as well. Just after an event, they needed cash fast to address a variety of challenges – emergency infrastructure repair, overtime salaries, humanitarian crises, etc.,” Linkin said.
“But as the economy has become more and more globalized, with increased interconnectedness and interdependencies between different locations across the globe, there has been increased interest from commercial buyers as well. In the past five to seven years, growth in the parametric space has been exponential.”
Much of that growth comes from the construction industry, which often has complex risks to cover.
Parametric policies can complement a traditional builder’s risk policy, covering costs associated with construction delays, increased cost of materials post-event, or any type of disruption and extra expenses resulting from an earthquake, hurricane or hail event.
“We’ve also found a niche for these policies within the construction space in part because we can write on a multi-year basis to match the term of the construction project,” Baki said.
“We see many insureds buy these policies to complement or fill in the gaps in traditional coverage.”
This of course is not limited to construction. The hospitality, retail and energy sectors, among others, can benefit from parametric policies as a bespoke contingent business interruption cover.
“There’s definitely not a single characteristic of a parametric buyer anymore because the use of the funds is so broad, it appeals to a broad swath of the economy,” Linkin said.
“Almost all commercial entities can benefit from parametric policies to protect against the unpredictable.” &