Questions to focus on when considering parametric insurance

Tips for sidestepping pitfalls and evaluating parametric solutions

Questions to focus on when considering parametric insurance

Risk Management News

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This article was provided by Berkshire Hathaway Specialty Insurance.

The beauty of parametric solutions for property insurance lies in their ability to bring simplicity and certainty to managing natural catastrophe risks for insured programs of all sizes. So why does assessing these solutions often descend into mind-numbing complexity? By working through the following five questions, you can cut through much of the complexity and gain clarity into the value a particular parametric solution will – or will not – deliver.

Where does the event data come from?

Parametric options use one of two structures: a “cat-in-a-circle” structure, also known as a “first generation” structure, which triggers when an event of a particular severity (e.g., a magnitude 7.2 earthquake) occurs in a specified geographic area, or a local intensity-based structure, also known as a “second generation” trigger, which pays when the hazard reaches a certain intensity at a particular location (e.g., peak spectral acceleration of 0.60g at the site), as measured and reported by an agreed-upon agency or instrument.

Generally speaking, first generation triggers based on event severity (e.g., moment magnitude of an earthquake or maximum wind speed associated with a storm) from a reputed scientific agency bring reliability, transparency and certainty to your program. Second generation parameters are typically derived from complex geospatial models and add uncertainty and complexity, especially when the model used is a black box or private recording instrument. You have to ask: Do I understand that uncertainty well enough to include it in my solution?

The other consideration is uniformity. Ideally, all solutions you are weighing should trigger based on the same publicly available information, such as from the National Hurricane Center or the United States Geological Survey or similar global agency. If they don’t, an apples-to-apples comparison is difficult. (And when you rely on publicly available data, you have access to the same date, and do not need to wait for someone to tell you whether an event triggered your coverage or not.)

Both first- and second-generation triggers can be tailored to provide your desired coverage, however, when you add the uncertainty associated with second generation triggers, the resulting coverage becomes more opaque. Simpler, uniform, and transparent is always better.

How would a proposed structure pay out in response to historical and scenario loss events?

Discussing various payout structures with various carriers ramps up complexity. One structure may pay differently for 100, 105, 110 mph wind speeds. Another offers a whole different scenario wherein the payouts are based on the category of storm and thus broader wind speed ranges. It can be difficult to compare the two solutions. However, if you simply ask how the proposed structures would payout against specific historical (and scenario) events, suddenly, the playing field is leveled. You have the clarity needed to evaluate one structure against another.

How does pricing measure up?

Once you see the historical payouts, you can easily put pricing in perspective. Any outliers in cost should raise eyebrows. While carriers offering the higher price are typically questioned, a carrier offering a substantially lower price should explain their rationale as well. Remember that the largest cost component of a premium is the expected loss; therefore, any substantial difference in premium is likely driven by a substantial difference in expected loss. After understanding how much coverage each solution is providing, ask for each carrier’s expected loss payouts. Cheaper is not always better, especially if it comes with inferior and/or inadequate coverage.

How can we put basis risk into perspective?

Every insurance solution carries basis risk. The basis risk in a parametric cover is different than that in an indemnity solution. An indemnity solution doesn’t provide coverage for losses under the deductible, over limits, exclusions under the policy or vagaries brought on by the adjustment process. A parametric solution is only different in that what is covered and what is not is known and is explicit in the policy (e.g., no payout for a Category 1 storm, or an earthquake less than magnitude 6). The pertinent issue is determining where you want coverage: for fast payment to restore business operations, for events that will disrupt your workforce, or for other gaps identified in your indemnity policy. Ask the carriers and brokers to evaluate a proposed parametric solution in conjunction with your indemnity policy, then fine tune the solution with your risk management objectives in mind. Understanding basis risk is a sound objective, but don’t let it become a roadblock to a sound parametric insurance solution.

Does policy wording point to simplicity or complexity?

From loss definitions and exclusions, to payment timelines and third-party involvement, policy wording is indicative of how complex (or simple) the coverage and claims response will be with a particular carrier. How much documentation is required? How quickly will claims be paid? Is there an additional adjustment after some time? How has the carrier paid out losses in prior events? Make sure all this information is clear, so you know precisely what you are signing up for. If the policy wording is complex, it’s taking away from the key benefit of parametric insurance – that it simply responds to an event in an unambiguous and transparent manner. As we said, simpler, uniform, and transparent is always better.

With BHSI’s FastCAT™ parametric solution, what you see is what you get – a simple, clear policy form, tailored to your specific needs, with customized triggers and coverage limits, transparent background analysis, and claims paid within 30 days -- guaranteed. You will see how the structure aligns precisely with your risk management objectives, how it will respond to historical and scenario events….and be certain that FastCAT will respond precisely as you expect it to.

At BHSI, transparency is central to everything we do, and core to our parametric insurance solutions. Parametric catastrophe coverage is simple. It should be simple to explain, and easy to get answers to the questions above from any market.

For more information, contact [email protected]/fastcat/

Sanjay Godhwani is Head of North America Property, Medical Stop Loss, Small Business platform and Programs business at Berkshire Hathaway Specialty Insurance. Sanjay has been in the insurance industry for over 25 years. Prior to joining BHSI, he was  President of AIG Latin America and Caribbean and Property Product Line Leader, AIG Property Casualty in the U.S. and Canada. Sanjay holds a Bachelor of Science degree from University of Illinois Urbana-Champaign and is a fellow of the Casualty Actuarial Society and a member of the American Academy of Actuaries.

Akshay Gupta is Senior Vice President, Head of Catastrophe Analytics & Engineering at Berkshire Hathaway Specialty Insurance. Akshay has more than 20 years of experience in catastrophe risk analysis, engineering, mitigation, and modeling. Prior to joining BHSI, he was Senior Vice President at AIR Worldwide where he built and led a practice providing engineering-based, site-specific risk modeling and evaluation for complex industrial and commercial facilities and operations. His background also includes catastrophe model research and development, supply chain risk modeling, and disaster risk financing and mitigation projects for corporations and sovereign states. He holds a bachelor’s degree in Civil Engineering from the Indian Institute of Technology in Delhi and earned a master’s degree and Ph.D. in earthquake engineering from Stanford University.

Berkshire Hathaway Specialty Insurance (www.bhspecialty.com) provides commercial property, casualty, healthcare professional liability, executive and professional lines, transactional liability, surety, marine, travel, programs, accident and health, medical stop loss, homeowners, and multinational insurance. The actual and final terms of coverage for all product lines may vary. It underwrites on the paper of Berkshire Hathaway’s National Indemnity group of insurance companies, which hold financial strength ratings of A++ from AM Best and AA+ from Standard & Poor’s.

Based in Boston, Berkshire Hathaway Specialty Insurance has offices in Atlanta, Boston, Chicago, Houston, Indianapolis, Irvine, Los Angeles, New York, San Francisco, San Ramon, Seattle, Stevens Point, Adelaide, Auckland, Brisbane, Cologne, Dubai, Dublin, Frankfurt, Hong Kong, Kuala Lumpur, London, Macau, Madrid, Manchester, Melbourne, Munich, Paris, Perth, Singapore, Sydney and Toronto. For more information, contact [email protected].

The information contained herein is for general informational purposes only and does not constitute an offer to sell or a solicitation of an offer to buy any product or service. Any description set forth herein does not include all policy terms, conditions and exclusions. Please refer to the actual policy for complete details of coverage and exclusions.

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