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Parametric insurance: How it can benefit construction companies

Discover how parametric insurance can pay out for natural catastrophes and more, in a matter of days.
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By Andy Desmond , 

Head of UK Business Development, UK Construction

14/03/2023 · 2-minute read

Climate change is triggering more extreme weather events. How can the insurance industry help?

The transitioning insurance market has made it more expensive for construction companies to insure against natural catastrophe (“nat cat”) perils. The market saw increases in capital and capacity worldwide leading up to 2017, partly due to the lack of natural disasters for several years. However, since then, extreme weather events have had a disruptive effect across the insurance industry.

Many insurers have become more selective about what risks they underwrite, moderating capacity in regions that are prone to extreme weather events. As a result, nat cat premiums have increased, leading insurance buyers to consider alternative forms of cover, including parametric insurance.

What is parametric insurance?

Parametric insurance, a policy triggered by the movement of a parameter (or index), has existed for over 20 years. It is flexible and can cover many scenarios and has been used successfully in sectors such as energy and agriculture to protect against exposure to extreme weather. Another example would be in the film industry, when coverage has even been sought when a certain number of hours of sunlight to shoot outdoor scenes is required.

A parametric insurance solution is a contract designed to insure a policyholder against the occurrence of a specific event, with the payout limit defined by the magnitude of the event. Parametric insurance offers flexible coverage for difficult-to-model losses, as the risk parameters are adjusted prior to the event and payment is triggered immediately by the event and scale thereof, resulting in faster payouts. For policyholders, this type of insurance offers claims transparency, and for insurers, it offers more simplified underwriting with capped liabilities.

With a traditional insurance policy, a premium is paid in return for the promise to cover the actual loss incurred for an incident or named peril. Payment is made only after an actual loss assessment and damage investigation has been completed following a claim, with the goal to put the insured back in the position they were prior to the event.

Parametric case study

Windstorm exposure: Replacing traditional capacity to improve coverage

Wind Storm Parametric – Western Australia

Background

Construction of a major chemical manufacturing plant in a high cat level cyclone zone of Western Australia. Due to windstorm accumulation issues in the region, the traditional insurance market was not able to offer any meaningful capacity for cyclone risk for the project. As a result the project was at risk of not being bankable leading to potential shelving of the project due to lack of funds.

Solution

Marsh squeezed the maximum capacity from the insurance market for cyclone totalling $150 million. In order to provide sufficient coverage against cyclone to satisfy lenders, Marsh arranged support for a parametric instrument alongside the insurance placement for a further $250 million triggered by a pre-defined event parameter at the project site.

This was achieved through Marsh’s unparalleled knowledge of the traditional insurance market, as well as those non-traditional markets. Thoughtful use of data and analytics allowed our team to garner competition for a parametric solution to access critical capacity.

Trigger

The trigger for the policy was a sustained wind speed greater than 200 km/h, with scaled benefits that increase with higher wind speed. 

Parametric insurance example:

Recently, a digital insurance intermediary launched a micro-insurance product to target underinsurance of nat cat and climate risks in the Caribbean. It monitors event wind speeds and the atmospheric pressure at the centre of a hurricane. If wind strengths reach pre-agreed limits, categorised as low, medium, high, very high or extreme, then a corresponding payment will be issued to the policy-holder. The platform fully automates distribution, claims processing and customer payouts within a maximum of 10 days following a hurricane, although it is often within 24 hours.

Because parametric insurance is an agreement to make a payment upon the occurrence of the triggering event, it is detached from an underlying physical asset or piece of infrastructure. It is also designed to indemnify without differentiating between the categories of costs incurred by the insured, which also makes claim payment faster and simpler.

A successful solution therefore pays the insured much more quickly than a traditional indemnity insurance, usually in days rather than months, and may in some instance compensate the insured for more of their true economic loss — the solution considers things like downstream impacts, increased costs, reputational effects, and contractual liability.

Parametric insurance for construction companies

While weather parametric insurance (nat cat or gradual weather) is most commonly thought to be of interest to construction firms, other forms are also available, such as cyber parametric insurance, which can operate on an index such as cloud provider downtime. As the construction industry becomes more digital and cloud-based, companies are becoming more interested in such cover.

Parametric coverage also recognises that contractors and owners face different economic risks from project delays. An owner may incur heavy revenue losses from operating profits that aren’t being realised. A contractor, on the other hand, can be impacted by high daily penalties when missing project deadlines. Payouts are simply based on indemnity and do not distinguish between the types of financial loss.

How parametric insurance can help with pandemics and terrorism

Innovative parametric solutions are being introduced to fill the gaps found in other types of coverage. This is sparking interest among potential insureds seeking solutions that expand capacity or protection not available in the conventional market.

For example, in the construction industry, instead of, or in addition to, taking out terrorism or pandemic cover, developers are considering footfall cover for shopping centres, so that if the footfall drops by a certain percentage outlined on the index, a payment is triggered. This could provide cover for gaps in pandemic and/or terrorism cover left by traditional insurance.

 

Local case study provided by Stephen Walker, Managing Principal, Marsh – Australia

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Maarten van Haaps

Head of Construction, Pacific

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Brad  Day

National BDM – Corporate Construction, Marsh Specialty

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