Viewpoint: Parametrics can close coverage gaps and pave the way for a climate-resilient industry

Closing existing coverage gaps in the market and tackling the problem of underinsurance are top priorities for the industry and governments around the globe.

Parametric solutions offer an alternative way to address these problems and give access to speedy financial redress to help communities and companies recover and rebuild after a loss.

In many developing economies, where agriculture accounts for a large proportion of GDP, the insurance gap problem is particularly acute.

For societies and economies that are at risk from natural catastrophes, the effects of climate change and the increasing frequency and intensity of severe weather events are highlighting a lack of insurance penetration. Solutions to help protect against financial losses and to help businesses rebound quickly are in high demand.

Secondary perils like flooding also have the potential to devastate crop yields – and these too are increasing in frequency and severity as a result of the changing climate. Not only do these losses directly affect developing economies, but they also have the potential to threaten global food security and disrupt value and supply chains across the world.

For governments and insurers, finding ways to address the issue of compensation for these losses and help support agriculture-dependent businesses to recover swiftly from them is of vital concern.

The role of parametrics

To date, there have been several government-backed risk pooling schemes aimed at trying to help societies and economies recover from financial losses, notably the Caribbean Catastrophe Risk Insurance Facility (now CCRIF SPC), which pays out to selected governments in that region following natural catastrophes.

There is now also a growing interest in using parametric solutions to facilitate payments to individual policy­holders in developing countries.

Unlike traditional indemnity insurance coverages, which require losses to be assessed and claims to be adjusted, parametric solutions are based on a trigger. If the trigger threshold is met or exceeded, the policy pays out swiftly. These triggers can be structured on a variety of measurable factors, such as windspeed for hurricanes, water depth for floods and rainfall levels – or lack thereof – for drought.

By using predetermined metrics, mutually agreed between insurer and insured, there is greater transparency in the claims assessment process, thereby enabling faster payouts. Carriers can use data to verify parametric claims immediately and pay out a pre-agreed amount.

More readily available technology and data is fuelling the trend towards parametric solutions and enabling solutions to be developed for a wide range of perils.

Parametrics in practice

An interesting real-world example of where parametric solutions have the potential to greatly improve efficiency in the claims process is the Indian agricultural sector.

India has had a government-sponsored agricultural insurance programme for some 35 years to provide payouts to small farmers when crops fail, but the system has often been criticised for inefficiencies and slowness in making payments.

Now, however, the scheme is making use of the new technology available, such as a mobile portal for reporting loss data and satellite and drone imagery that can give remote assessments of crop damage.

These innovations are helping drive claims automation, increasing efficiency in the system and, crucially, making the scheme a more attractive solution for insurers and reinsurers.

We expect [parametric solutions] to gain greater traction as a complementary form of coverage in areas where insurance and reinsurance is hard to secure – particularly in hard market conditions

Another great example where parametric solutions could be used to help address underinsurance is Sri Lanka, which is exposed to a variety of natural catastrophe risks including earthquakes, quake-induced tsunamis, tropical cyclones and excess rainfall. New Dawn Risk worked with a client in the region and a UK government-backed parametric reinsurer to design a parametric coverage that would respond to that range of perils.

The proposed coverage triggers were based on a wide variety of data and analytics. The earthquake coverage, for example, used historical quake data, stochastic modelling and science from academic, public and private sources to simulate synthetic earthquake events and develop a suitable trigger.

Future trends

Increased interest in parametric solutions is being driven in large part by the need for swift payouts that help businesses rebound quickly from a loss. 

The current hard insurance market, which is particularly notable for natural catastrophe coverages, where rates have been hiked and terms and conditions tightened in response to the increased frequency and severity of losses, is prompting insurance and reinsurance buyers to look for alternative or complementary solutions.

There is increasing appetite from investors too, with several high-profile venture capital firms setting up parametric trading platforms or investing in them in recent months.

Parametric solutions are not a competitor to or replacement for traditional indemnity coverages. That being said, we expect them to gain greater traction as a complementary form of coverage in areas where insurance and reinsurance is hard to secure – particularly in hard market conditions.

As well as their potential to help address the protection gap in areas prone to natural catastrophes, para­metric solutions can also be tailored to cover other hard-to-insure losses, such as non-physical damage business interruption, for example.

With the looming threat of climate change, we expect to see greater interest in this type of coverage, especially as confidence in parametric solutions continues to grow. 

Aditya Singh is head of treaty at New Dawn Risk