Parametric insurance is gaining ground as a preferred alternative to traditional insurance products. Especially as corporate budgets and market capacity tighten amidst extreme weather losses, and continued uncertainty from climate change and the global inflation crisis. Discover the new trends emerging for parametric products as more corporate clients around the world seek out parametric products.
The rise of parametric insurance – is there a need?
Climate conditions today are much stronger than they were 20 years ago. We see this in recent events such as Hurricane Ian being the costliest natural catastrophe globally in 2022, with over $95.5 billion in total economic loss and nearly half of those damages left uncovered. Most disaster losses were uninsured in 2022, resulting in a 58% protection gap.
In the Summer of 2022, Europe suffered its worst drought in 500 years, impacting all major rivers, particularly the Rhine, where average barge loading was reduced by 75% in August. The drought also saw staple grain yield fall 16% below the previous five-year average and contributed to the ignition of wildfires that set off health warnings throughout the EU. The year prior, catastrophic floods also hit Europe, leaving a trail of destruction, particularly in Germany, where the total cost of the damage was estimated to be more than €30 billion.
With industry players fleeing the market, removing challenging geographies or simply excluding climate-related triggers, it’s no surprise only 42% of last year’s losses were covered by insurance. As the insurance industry continues to face an increasingly hard market compounded by Nat Cat losses, inflation and uncertain geopolitical conditions, there is no denying that it needs to redefine and reinvent. Especially as carriers continue to reduce the capacity supply while the demand for such protection increases at an alarming rate.
Parametric insurance is gaining ground as a preferred alternative to traditional insurance products. Especially as corporate budgets and market capacity tighten amidst extreme weather losses, and continued uncertainty from climate change and the global inflation crisis. An increasing number of brokers and their clients are judging parametric products as more relevant to their needs due to price and certainty of what is covered in their policies.
What exactly is Parametric Insurance?
Parametric insurance is a specialized form of coverage designed to address the challenges posed by disasters further fueled by climate change and other new emerging risks, like cyber. Unlike traditional insurance, which relies on lengthy loss-adjustment procedures, parametric insurance operates on predefined, objective indicators. It pays out pre-agreed indemnity when a catastrophic event occurs, triggering the coverage parameters set in the policy contract.
The key component of Parametric Insurance lies in the use of objective indicators, known as ‘parameters,” which serve as an accurate and reliable measure of the extent of natural disasters and emerging risks. This can include the height of a coastal wave, the intensity of the ground shaking during an earthquake, or the peak windspeed at a specified location. If the insured event occurs, the policy pays out a pre-agreed sum.
In the event of a cyclone, earthquake or other triggering event that meets or exceeds the predefined parameters, the impacted client will receive time payouts, allowing for a faster recovery and reducing financial uncertainty. Parametric insurance solutions can also apply to the full financial impact of a loss event, including non-damage business interruption, lack of access or tourism attractivity, which traditional insurance carriers cannot provide cover for in most cases.
How exactly does parametric insurance work?
Unlike traditional indemnity insurance, which relies on lengthy loss-adjustment procedures, Descartes’ parametric insurance pays out when a predefined event (i.e. typhoon, cyclone, earthquake etc.) occurs as measured by a specified parameter or index such as rainfall, wind-speed or peak ground acceleration. Driven by objective data and real-time monitoring from ground-based sensor technologies, radar, and satellite imagery. Descartes’ parametric coverage utilizes advanced data and technology to monitor your risk, real time with no the ground loss adjustment required, should a claim occur. Offering you peace of mind and precise protection.
Parametric insurance solutions aim to minimize basis risk – which is intrinsic to insurance – through technology and advanced data. Combined with new and emerging AI techniques, Descartes’ products can accurately reflect the insured risks and provide exposed clients with a more comprehensive understanding of their exposures.
Emerging trends of parametric insurance
As parametric insurance has gained traction in the market, more corporate clients around the world are seeking out parametric products. Continuous data advancements and the emergence of new AI-driven technologies have led parametric products to be more robust, subsequently increasing buyers’ appetite. Incorporating satellite and radar technologies, machine learning, and advanced physics into underwriting models has also enabled a more precise understanding of risks and a more granular approach to pricing.
This approach is expected to better incorporate the cost of climate change. Likewise, because parametric products are priced based on the likelihood of an event happening, pricing remains stable following loss events, providing clients with an alternative to the frustrating volatility of traditional market pricing. What’s more, with the certainty of parametric products, vastly more of the premiums spent on coverage are returned to policyholders as claims, instead of being spent on frictional costs and disputes.
As climate change continues to evolve and new risks emerge, certain lines of business are struggling to find Nat Cat capacity, inspiring corporates to ask brokers to deliver parametric solutions. The areas seeing the most traction are renewable energy, agriculture, manufacturing, tourism, construction and the hospitality industry. But the bottom line is that any insurable interest affected by or exposed to Nat Cat & extreme weather events requires alternative risk transfer solutions. Parametric insurance is proving to be the optimal solution as it applies agnostically to many industries and is much less concerned about the asset type but instead is client-customized to take into account the full spectrum of financial loss in the case of a triggering event. This enables clients to address the broader economic impact a climate event has on their operations, clients, suppliers and vendors, including financial exposures and non-damage business interruption, which is vastly underinsured by traditional carriers.
As technology and innovation have become infused in many sectors, insurance remains one of the most outdated industries, where the traditional model has remained unchanged for 800 years and no longer serves the greater community affected by intensifying natural catastrophes.
For example, an ongoing construction project in North America that frequently experiences excess precipitatioon may not suffer from actual physical damages, other than wet equipment. However, they could still see other significant losses in terms of time and employees being unable to work, which inevitably causes delays. Traditional indemnity insurance pays out when it is deemed actual physical damage, where intangible losses like drop in energy production is not considered a loss.
However, with parametric insurance, the bespoke policies insure clients against the magnitude of events, even calculating potential business interruption using pre-defined parameters. Ultimately, this ensures everyone wins.
More trust, more investment
Significant capital has also flowed into the parametric space over the past few years, which reflects broader recognition of the value and the increasing importance of parametric products in modern corporate risk management. Traditional insurance, on the back of cyclical trends, market hardening, and year-on-year losses, cover for Nat Cat perils has become less attractive to buyers, with increased exclusions, less capacity, and higher pricing. Parametric insurance has inevitably been evolving to fill the gap left behind by the traditional market.
The power of technology in parametric insurance policies
The emergence of new technologies, such as IoT, will continue to enable parametric insurance to stay ahead. New technologies provide parametric providers like Descartes to have a deeper grasp on climate and emerging risks. Additionally, the use of IoT-driven warning systems can inform exposed clients of potential risks, enabling them to take preventative measures before they endure costly damages. Providers can also better understand industry trends and continue to create innovative models amidst an evolving climate landscape.
Large language models (LLMs) are also having a strong impact on many industries, including insurance, particularly as it has the potential to transform underwriting completely. LLMs have the power to process large amounts of data quickly, like historical events or claims history, potentially enabling underwriters to predict future claims better.
Combining parametric with traditional covers
We are also witnessing significant growth in the market’s ability to better construct parametric policies in full conjunction with traditional covers, essentially a hybrid cover. For example, a client could take advantage of having traditional indemnification for property damage, but all NDBI or financial loss covered through parametric policy.
In the hospitality industry, this could mean immediate liquidity for cleaning and revenue losses, where loss adjustment applies to furniture and property damage. As mentioned, the current product offering designed over centuries ago by maritime insurers is no longer relevant today. Hybrid products, however, could provide more reliable and predictable compensation that reflects a client’s actual loss.
Parametric insurance is here to stay
The rise in parametric insurance uptake marks the industry’s evolution, where we finally see the need to reinvent insurance and do it differently. It is clear that traditional cover is suitable for many exposures but not ideal for all as many corporates and businesses continue to face so many uninsured exposures.
As risk carriers, underwriters, brokers, and insureds recognize an alternative and complementary approach to risk transfer, the parametric market will continue gaining significant traction. This will call for even better cover for secondary perils that aggravate the market due to their complexities, such as wildfire, flood and hail.
Through extensive use of data for pricing, parametric insurance immediately simplifies the underwriting process, reducing the amount of time required to quote and bind a policy and eliminating embedded costs. Claims settlement is agreed upon in advance, allowing for rapid cash disbursement to businesses and communities facing insolvency in the wake of extreme weather events. This immediate infusion of capital helps prevent lasting economic impacts.
Only data-driven insurance and completely independent underwriting can reconcile and drive capital in front of such high and unpredictable perils. Parametric providers like Descartes are enabling and reconciling capital and climate risk to build the future of insurance, ensuring it remains a resilient and profitable industry. Investing in insurance innovations is vital to identify growth areas where we can continue to create substantial value for the industry.
