The Rise of Parametric Insurance in an Increasingly Disaster-prone World
The New Disaster-Prone Normal
Natural disasters are now occurring with a greater frequency and severity than ever. At the same time, populations and businesses continue to move to cat-prone geographies most at risk; including coastal communities (like Florida and North Carolina) and urban centers (like Los Angeles and Houston).
A five-year look reveals an eye-watering tally in excess of $600B. These events have had a significant impact on the traditional insurance market’s ability to take risk. Consequently, premium rates hardened, deductibles and self-insured retentions increased, and certain exposures are entirely self-funded out of necessity, not desire. When compared to historical norms and in this context, balance sheets are more leveraged than ever.
Enter, Parametric Insurance
Parametric insurance is nothing new. In fact, the concept has been around since the ’90s to cover the probability of a predefined event, such as a natural disaster.
Today, these alternative risk transfer mechanisms are increasingly relied on due to a fundamental shift in the climate risk landscape and a corresponding increase in the industry’s technological capabilities, which allows parametric insurers to obtain data previously not contemplated during the underwriting process.
Parametric structures, when deployed correctly, can offer clients a level of protection that addresses otherwise uninsured economic damages not contemplated by the traditional insurance market.
This doesn’t mean parametrics are meant to replace traditional insurance coverage completely. Rather, they should be thought of as complementary or supplementary. Parametrics offer an insured the ability to address losses arising from a climate event regardless of whether or not there is physical damage. For example, a ski resort can insure against a lack of snow days or a corporation can cover supply chain business delays and losses caused by a weather event. These events can include hurricanes, earthquakes, floods, hail, wildfires, tornados, freeze, excess heat, and so on.
Benefits of Parametric Insurance Coverage
Triggering coverage off the underlying event also allows insurers to settle claims much more efficiently than the traditional market as the structure in effect pre-adjudicates a claim. The ability to pre-fund a loss represents a fundamental shift in how an insurance contract responds. From a corporate finance viewpoint, a parametric insurance product - with an almost instantaneous payout - can offer significant advantages over a traditional policy, where claims settlement processes can take weeks, months, or even years.
Commercial clients aren’t the only ones seeing the benefit of parametric policies. In a 2019 report, FEMA stated parametric insurance was integral to closing coverage gaps and overcoming an increasingly less robust federal disaster response. The realities of today’s world dictate that FEMA cannot respond as in the past; parametrics help shift this catastrophic burden off the back of the taxpayer and into the private sector.
Whether you’re a risk manager or broker, commercial organization, or public entity, parametrics offer rapid response and tremendous flexibility for an evolving and uncertain future.