How Banks can use Parametric Solutions to protect their Credit Risk Exposures from Nat Cat Events
Case Study: Credit Risk Cat Nat Protection for Banks
Natural disasters and loan defaults are strongly correlated particularly for financial institutions in highly exposed areas such as the Caribbean which are susceptible to Hurricanes . This is compounded by the reduction in credit insurance capacity which has been driven by factors such as the COVID 19 crisis.
A collaboration between Howden, the international insurance broker, Skyline Partners and Munich Re have developed a product that protects the Jamaican Co-operative Credit Union League (JCCUL) against non-repayment of micro-loans from farmers in the event of extreme weather.
The Jamaican Co-operative Credit Union League is relied upon for loans by 100,000 smallholder farmers to cover the cost of essentials, such as seeds, day-old chicks and farming equipment. Farming is the main source of income for around 18% of the Jamaican population.
Adverse weather events could lead to farmers being unable to repay their loans, putting the JCCUL’s ability to continue to offer financial support at risk.
The insurance product, which is based on a parametric trigger, replaces funds lost as a result of farmers defaulting on loans in the event of an extreme hurricane. The is designed to trigger for the full limit when the hurricane wind field of category 3 and above covers the whole of Jamaica.
The methodology has been developed through dividing Jamaica into tiles to ensure that they are able to accurately pay-out the areas that have been affected. The policy also provides protection for hurricanes where the eye doesn’t directly hit the island but payment will still be made with any of the resulting hurricane winds (cat 1+) hitting Jamaica (based on the hurricane wind field hitting the various tiles across Jamaica).
The solution comes with its dedicated risk visualisation software to monitor events to assist the client with the risk awareness and the settlement of claims in line with the policy terms. The tool comes with history of hurricanes since 1850, as well as 10,000 years of synthetic storms. This type of solution can be tailored for other Nat Cat perils including Earthquakes, flood, wildfire, winter storms anywhere in the world.
Conclusion
Parametric solutions offer new ways of protecting against risks that are otherwise not sufficiently covered and the market is growing significantly.
Milliman and OneRisk Consulting are working in partnership with Skyline Partners to provide an integrated advisory service that tailors parametric solutions through a proof-of-concept process and where we have access to climate data; technology platforms to enable the design of bespoke solutions to support our clients’ needs.
Our advice is very much based on a collaboration with our clients to provide independent quality assurance and best practice guidance.
References
Gründl, H. & Schmeiser, H., 2002. Pricing Double-Trigger Reinsurance Contracts: Financial versus Actuarial Approach. The Journal of Risk and Insurance, 69(4), pp. 449-468.
Jiao, L. & Bao, Z., 2020. The Pricing of Double Trigger Catastrophe Put Option with Default Risk. Asian Journal of Probability and Statistics, pp. 38-50.
Radu, A., Sabatié, L. & De Santis, D., 2021. Boxing clever: novel thinking behind parametric products. [Online] Available at: https://www.theactuary.com/features/2021/10/07/boxing-clever-novel-thinking-behind-parametric-products [Accessed 17 March 2022].
Ravagnolo, O., I., M. & Hoogenboom, G., 2000. Genetic Component of Heat Stress in Dairy Cattle, Development of Heat Index Function. Journal of Dairy Science, 89(3), pp. 2120-2125.
Howden partners with Skyline and Munich Re to protect Jamaican farmers from extreme weather events 26 April 2022 - Howden Website News Article.