The parametric revolution – why the market is poised for dramatic growth

Parametric insurance is enjoying a surge in popularity amid a hard property market. As markets begin to see the advantages this type of insurance can offer, the utilization of parametrics will also expand beyond the property and casualty space.

Alex Kaplan (pictured), executive vice president of alternative risk at Amwins Group, believes the parametric revolution has only just begun.

“This base will continue to grow dramatically over the next handful of years, in terms of the sophistication of the markets and the structures that they can offer, as well as the amount of capacity that is available in the space,” he said.

The global parametric insurance market is projected to more than triple in value within the next decade, according to data by Allied Market Research. The market was valued at $11.7 billion in 2021 and is estimated to reach $29.3 billion by 2031.

Parametric insurance appeals to the market because it cuts the elongated claims and adjustment processes that come with traditional insurance products, Kaplan noted.

“You’re either in or you’re out – and insureds like that, too. They like that level of clarity, particularly those who have had historical losses,” he said.

“Being able to be done and dusted on a parametric claim inside of two or three weeks is very valuable.”

Born of troubled times

Parametric insurance traces its roots back to the turmoil in the property and casualty insurance industry in the 90s.

Hurricane Andrew had dealt unprecedented damage to Florida and the Gulf Coast in 1992, causing some $27 billion in damage – roughly half of which were insured. The devastation drove eight insurers to failure and tipped others to the brink of insolvency.

In bid to inject more capital, the industry introduced a new instrument to transfer hurricane risk to capital markets. The first payout from this instrument, dubbed a catastrophe or “Cat” bond, was recorded in 1997.

Catastrophe bonds were based on predefined parameters, such as the earthquake magnitude or wind strength. If these parameters were met, the bond would trigger a payout to the insurer.

The success of catastrophe bonds paved the way for modern parametric solutions, which have become increasingly sophisticated and data driven.

“Parametric insurance covers every natural peril at this point. It started in the Nat Cat space, but now it’s branched out to include management liability, financial lines, and cyber,” said Kaplan.

The Amwins specialist attributed increased awareness and need for alternative risk transfer products as the main drivers of growth in the parametrics space.

“The level of awareness has ticked up quite dramatically over the last decade. In the past 10 weeks or so, we’ve seen a massive uptick in the volume of inquiries or submissions for parametric coverage,” he told Insurance Business.

What are the benefits of parametric insurance?

Parametric insurance offers pre-specified payouts based upon a trigger event. Trigger events can depend on the policy, which could include environmental factors, such as wind speed and rainfall measurements.

The data is typically publicly available and often real-time data, which allows insurers to establish a baseline for the parameters.

There are three main benefits to this non-traditional set-up, according to Kaplan:             

The first benefit is speed of payout. Since insurers use real-time and publicly available data, the claims can be paid very quickly, in most instances under three weeks.

“This affords cash flow and liquidity, which allows business to recover faster from an event,” he said.

The second key benefit is the flexibility on use of the proceeds. The policy indemnifies the insured against the circumstances around an event, rather than an underlying portfolio of actual losses incurred.

The insured can then use the proceeds however they see fit, provided it covers any direct or indirect financial loss associated with that triggering event.

The third key benefit is transparency. Everything is predefined in the parametric insurance contract, and there’s no ambiguity over when, how, and how much the contracts is going to pay out.

“Often, people’s biggest complaint about insurance is that it’s too slow and it’s too ambiguous. Parametric insurance serves to alleviate those two chief complaints,” said Kaplan.

What does the future of parametric insurance look like?

Historically, parametric insurance was used by companies that have an uninsured exposure on their balance sheet that they couldn’t find coverage for in the traditional market.

One reason is that good underwriting data didn’t exist for those exposures, which is why parametrics initially took off in emerging markets like sub-Saharan Africa, Southeast Asia, and Latin America.

“Parametrics started to come in at much greater scale in advanced economies like the US simply because people realized the amount of total risk against what is insured is still very large,” said Kaplan.

Advancements in technology have also vastly improved the quality of data used for parametric insurance. The increased use of remote sensing technology and satellite data will play a key role in the evolution of parametric offerings.

“With remote sensing technology, you have the ability to measure hail stone size, for example, or the velocity a hailstone hits a particular roof, or the depth of floodwaters in real time at a specific site,” Kaplan said.

Another trend in parametric insurance is the emergence of non-damage business interruption, where insurers can now use economic performance metrics as a barometer of risk.

“We can look at signals in these economic data sets as a proxy for loss. If you have a hotel in a tourist area, and suddenly, airport passenger arrivals dropped by 30%, you will suffer losses. That can serve as the proxy for the trigger,” said Kaplan.

“To measure the loss, we can look at credit card transaction data, occupancy rates in nearby hotels, and a handful of other trigger designs.”

How can brokers get their clients started on parametric insurance?

Organizations that approach five different parametric insurance providers will likely get five different structures if they’re not specific about what they want to achieve. Brokers must guide their clients through the market and help them compare options, said Kaplan.

“Insurers need to see the schedule of values, to know where things are located, and how much they’re worth. Loss history is helpful for benchmarking the trigger design against the performance of the account and those historical events.

“But most important is the commentary. Why do you want a parametric? What is the objective? What problem are you trying to solve? Because that will dictate what the trigger design looks like,” he said.

Ultimately, parametric insurance is a tool that organizations can add to their risk management arsenal. It wouldn’t replace other traditional covers in place, but act in conjunction with one another to create a more comprehensive risk management strategy.

“The way I think about parametric insurance is not as property insurance; it is balance sheet protection,” said Kaplan. “It is a hedge against a defined uncertainty.”

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