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Parametric insurance: Coverage option as Pacific storm season approaches

With the 2021-2022 cyclone season coming in November, it’s time to consider whether parametric coverage has a place in your risk finance strategy.

In Australia, traditional insurance products remain the backbone of risk transfer strategy for most organisations. However, escalating costs, higher deductibles, and stricter terms and conditions — at a time when recovery from the COVID-19 pandemic is ongoing — have many organisations looking to supplement their program with alternative risk finance options, including parametric products.

Overall insurance pricing in the second quarter of 2021 in the Pacific region increased 23%, continuing an upward trend that began in 2015, though the rate of increase has moderated for two consecutive quarters. Property insurance pricing rose 14%, on average, in the second quarter, less than the 20% increase seen in the first quarter.

Organisations with higher exposure to storms and cyclones will likely experience higher than average increases and, in some cases, could face reductions in the amount of coverage available. With the 2021-2022 cyclone season coming in November, it’s time to consider whether parametric coverage has a place in your risk finance strategy.

What is parametric weather insurance coverage?

Payments from parametric, or index-based, solutions are linked to an agreed-upon and specific trigger, such as wind speed or water height at a particular location. Unlike traditional coverage, parametric solutions/index solutions:

Do not require physical damage to trigger coverage.
Typically provide a faster claims and payment process.
Generally provide payment if the predetermined trigger is breached, and any other terms of the contract are met.
Are customised to your company’s individual needs and exposures, and are linked to a pre-defined index that provides the needed measurement.

What is an example of parametric insurance?

Consider a coastal port asset that receives significant damage from a Category 4 storm with winds gusting to 225 kph. The losses fall within the company’s property policy deductible. Although damage to ancillary services halts production and leads to spiralling business interruption costs, without a business interruption policy, the organisation is forced to absorb the losses. Even if the company had sufficient business interruption coverage, payment typically takes several months.

Now consider that the same storm causes heavy damage and disruption to another company, which had supplemented its property policy with a bespoke, index-based trigger that starts paying out when wind speeds top 150 kph. The storm qualifies, and the company is able to access funds within a few weeks to rebuild and restart operations.

Even when traditional insurance is available, companies in the path of a cyclone — or another natural disaster, like a hail storm — often undergo a long and difficult process to quantify costs beyond direct property damage. The traditional property and business interruption claim settlement process can be lengthy, leaving companies with less liquidity in the meantime.

What are the common triggers in parametric insurance contracts?

The most common triggers are natural catastrophe perils such as cyclones, earthquakes, bushfires, hailstorms, and floods. Triggers can also include other adverse and prolonged weather events, such as excess temperature, droughts, and insufficient sun/wind conditions. Data and technology are making possible additional triggers, such as vegetation or biomass growth, retail foot-traffic, pandemic-related scenarios, and cyber outages.

What is the role of a broker?

Organisations should work with their brokers to determine whether parametric solutions are right for them. This starts by understanding the risk in having a parametric product, and how it might supplement and/or complement an existing insurance program.

How do parametric insurance and traditional insurances work together?

As traditional insurance market conditions become increasingly challenging, organisations are looking to parametric insurance solutions to complement and/or supplement traditional insurance programs. In particular, this is becoming an increasingly popular option for the natural catastrophe (“NATCAT”) risk and coverage component of property programs.

With premiums for lower layers of property programs becoming comparable — or higher — than those for parametric coverage, index-based solutions are becoming an attractive alternative.

In partnership with organisations and current insurers, a broker will work to understand the pain-points for either party, and structure an appropriate, cost-effective parametric solution to fill any gaps left by traditional insurances.

Is a parametric model right for you?

Considerations in determining if a parametric solution is a viable option for your organisation include:

Whether cost savings of increasing deductibles for named windstorms within traditional policies can be used to purchase parametric coverage as a supplement to those policies.
If the organisation is comfortable with self-insured retentions in their traditional programs and other terms, such as waiting periods.
The importance of a quick settlement and immediate liquidity after an event.
Whether contingent and non-physical damage losses constitute a significant exposure.

Parametric solutions are unlikely to fully replace traditional property coverage when it comes to natural catastrophe exposure for most companies. But when used in conjunction with existing policies, they can provide an additional line of defence, helping to maintain liquidity and more quickly restore operations after a storm.

Parametric insurance real-life case study

Who/Client: An industrial operator in far north Queensland

Problem: Due to the underlying nature of risk, the client was unable to obtain coverage on property risk from traditional insurers. This was following a period during which the market saw a number of insurers withdrawing coverage for organisations with assets in far north Queensland, citing a change in appetite, capacity, and profitability concerns.

Solution: Marsh designed a bespoke parametric insurance policy to protect the client against cyclone risk. We secured coverage with a well-rated international insurer for a 12- month period, on a renewable basis. The coverage ensures that payment for a qualified claim can be made within 30 days of an event, regardless of actual property damage at the location.

Outcome/Achievements: The client will be compensated if a covered cyclone event causes supply disruptions, such as road/bridge closures, and assures that the injection of liquidity will arrive quickly. This was critical to alleviate a lender’s concerns regarding adequate protection against major external disruption to operations from cyclones.

This document is not intended to be taken as advice regarding any individual situation and should not be relied upon as such. The information contained herein is based on sources we believe reliable, but we make no representation or warranty as to its accuracy. Marsh shall have no obligation to update this publication and shall have no liability to you or any other party arising out of this publication or any matter contained herein.

Any statements concerning actuarial, tax, accounting, or legal matters are based solely on our experience as insurance brokers and risk consultants and are not to be relied upon as actuarial, accounting, tax, or legal advice, for which you should consult your own professional advisors.

Marsh makes no representation or warranty concerning the application of policy wordings or the financial condition or solvency of insurers or re-insurers. Marsh makes no assurances regarding the availability, cost, or terms of insurance coverage.