Parametric Insurance Market

How are Parametric Solutions Structured?

The parametric market has existed for around twenty years, with an initial major focus on weather risks. However, it is yet to scale with only a few experienced niche providers, risk carriers and large cover buyers (utilities, energy companies, governments) transacting with over-the-counter derivatives or large re/insurance transactions.
With the rise of new datasets, satellites and IOT sensors, parametric or index-based insurance solutions are expanding fast and becoming provides an alternative or in many cases the only option to insure risks that can provide organisations with improved resilience. It works particularly well by covering risks where traditional indemnity insurance struggles, such as non-physical property damage related losses, contingent business interruption, etc.

Parametric Insurance vs Traditional Indemnity Insurance

A traditional loss or liability contract insures a policyholder against financial loss. A loss occurs, the insurance company is notified, the loss is assessed and compensatory payout is determined.
Parametric policies are in general 12 months but can be structured on a multiyear basis. Renewable energy products can be up to 10 years, natural disasters up to 3-5 years.
Parametric solutions cover the probability of a defined index exceeding a given loss-correlated trigger (rather than any resultant financial loss) and pay out in an agreed manner upon the manifestation of said event. This is a contract between policyholder and insurer, which dispenses with the requirement for assessment and related expenses.

Structuring a Parametric Solution

To function in a way that meets a policyholder’s requirements, a parametric solution should meet particular criteria:

1. The index and trigger on which the policy hinges should be clearly-defined; to construct a parametric solution dependent on the occurrence of a hurricane, policyholder and insurer need an agreed and objective definition of “hurricane”.

2. The index on which the policy hinges should be objectively measurable; similarly to the above, if a policy is structured to pay out upon a certain amount of rainfall, a method and geography of observation should be agreed upon. Usually, this will rely on independent 3rd-party data and monitoring;

A well-structured parametric solution:

· Be flexible for the policyholder: the level of optionality in definition of index, trigger, modes of measurement and payout structure allows for bespoke, tailored solutions;

· Provides a seamless transition from event to payout: in obviating the need for loss assessment and potential points of disagreement over loss incurred, parametric solutions allow for faster and smoother realisation of payouts based on verifiable and clear-cut triggers.

· Expands insurability: parametric solutions may be appropriate in many cases where traditional insurance is unavailable or prohibitively expensive.

It is worth noting that a trigger need not be a single event or peril; many solutions involve a series of marginal triggers with associated payouts at each threshold. Therefore trigger points may be based on an accumulation of chronic conditions over a given timeframe such as total amount of rainfall or average temperature over one year or say a Summer or Winter seasonal period.
The index should also, of course, be independent of the actions of either the insurer or the policyholder – if the index can be influenced by either party, it ceases to be a fair and objective benchmark on which to base a policy.

Payment of Claims

When the index diverges from the agreed range, coverage kicks in and the payout is determined according to a pre-agreed mechanism. However, premiums for a parametric policy tend to exceed premiums associated with a traditional insurance policy. This is mostly in order to compensate insurers for commensurate benefits offered to policyholders by these policies.
The payout is agreed upon in advance and cannot be adjusted downwards as a result of loss assessment, and the insurer may need to pay out a range of highly covariant policies almost simultaneously if they are linked to highly correlated indices.

One Risk Consulting is in Partnership with the leading Parametric Insurance provider Skyline Partners, which can structure solutions across a range of perils and industry sectors.
Contact me for further information: martin.massey@oneriskconsulting.com