In traditional programs such as property damage and business interruption (PDBI) insurance, insurers and reinsurers are facing pressure to increase premiums while limiting capacity1. For instance, peak natural catastrophe (Nat Cat) perils such as earthquakes are increasingly excluded from PDBI programs, whilst insurers are also raising deductibles for covered perils to alleviate losses and companies having to retain more risk2.
Beyond narrowing terms and capacity, further increasing the potential for uninsured losses are Nat Cat events that do not result in physical damages, such as a typhoon and its aftermath causing a drop in hotel occupancy, resulting in a financial loss not covered by traditional PDBI insurance.
Amidst this backdrop, parametric insurance — also sometimes known as index-based insurance — is becoming a popular complementary solution to fill the gaps left by PDBI coverage as companies can receive claims payouts with greater speed (typically within 30 days) and certainty (by eliminating the need for a claims and loss investigation process). Hence, parametric insurance allows the insured to swiftly begin the recovery process following a risk event without having to complete the traditional PDBI policy’s lengthy claims process.
How does parametric insurance work?
Parametric insurance is a highly tailor-made risk transfer solution structured around an independent third-party index — such as by the Japan Meteorological Agency (JMA) — and pre-agreed payout formulas set by the underwriter. The parametric insurance payout is triggered when the index meets or exceeds a predefined threshold, such as 10-minute sustained wind speeds of at least 150km/h.
The benefits of parametric insurance include:
- Certainty of payout as coverage is based on a predetermined trigger.
- Faster payouts that offer much-needed liquidity in times of need.
- No additional claims management costs as payout is set in advance.
- Customised coverage to meet specific business needs at competitive pricing.
To select the best index and payout formula and ensure the pre-agreed payout accurately reflects the actual financial loss caused by the peril covered, modelling and structuring should be conducted by an experienced risk advisor prior to placing the policy and restructuring of the insurance portfolio.
What is the difference between parametric and traditional insurance?
Compared to traditional insurance coverage that requires verifiable material losses from a risk event for a claim submission (with potential for additional costs incurred in managing the claim), a risk event covered under parametric insurance is verified by a third-party with payout issued within a few weeks. This seamless index-based claims process provides businesses with upfront liquidity in times of need, considering that loss adjustment in a PDBI claim recovery can be a lengthy process.
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With its ability to provide reliable coverage and efficient settlement for events where losses can be extensive and difficult to define within traditional policy wordings, parametric insurance is widely used as a complement to traditional PDBI insurance coverage. The two policies combine to ensure robust coverage for direct and indirect economic losses due to probable risk events including earthquakes, typhoons, floods, drought, wildfires, crop failure, pandemic, and terrorism.
Here are 3 scenarios demonstrating how parametric insurance can be structured to help businesses achieve their desired Nat Cat protection for typhoon risk.
In Scenario 1 above, a “carve-out” option in the PDBI policy allows the difficult-to-place risk to be completely removed and covered with the parametric solution.
In Scenario 2, a “buy-back” deductible option allows a part of the risk to be replaced by parametric coverage (e.g. US$10 million).
In Scenario 3, the parametric cover supplements the PDBI policy, with the parametric solution tailored for coverage against non-damage business interruption and uninsurable assets etc.
While parametric insurance can provide more comprehensive coverage against extreme weather perils as a complement to a PDBI policy, one of the key concerns is basis risk.
Addressing basis risk in parametric insurance
When it comes to parametric insurance, a key concern is basis risk where the actual loss exceeds the payout amount due to the magnitude of the risk event and/or the predetermined payout formulae. (Basis risk also exists in traditional insurance, where payout is not predetermined and is subject to adjustment due to the average clause, exclusions, sub-limits, and deductibles.)
By partnering with an experienced risk advisor with robust parametric modelling capabilities to determine the optimal structuring, you can ensure that the predetermined payout of your parametric cover is aligned to your loss exposure and premium expectations, and correspond as closely as possible to the actual loss sustained.
Learn more about enhancing business resilience with parametric insurance
As the global leader in risk management and insurance broking, Marsh has successfully helped companies across Asia and globally mitigate extreme weather risk exposures on their non-damage business interruption losses with tailored parametric coverage backed by robust modelling and structuring capabilities. Leveraging its extensive global carrier network, Marsh’s parametric cover forms part of an alternative risk transfer solution that empowers companies to overcome issues such as NatCat capacity constraints and coverage gaps.
To explore how you can incorporate parametric solutions into your insurance portfolio optimally, get in touch with a Marsh parametric expert or watch this webinar video to learn more about case studies on how we structured and implemented tailor-made parametric solutions:
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