Index-based insurance, otherwise known as parametric insurance, is gaining steam and insurance organisations who offer these solutions can be more competitive in the global insurance marketplace, in addition to offering organisations crucial insurance tools amid intensifying climate risk.
That was one of the central messages AXA XL leadership delivered during a Fast Fast Forward event on parametric insurance earlier this year. The global insurance company’s parametric insurance experts were on the road in February, meeting with clients from private and public organisations, as well as non-profits interested in how index-based insurance can help them manage growing climate change-related risks across a wide range of sectors, such as construction, food and beverage, renewable energy, agriculture, transportation, and tourism, alongside others.
“Our conviction is that parametrics is a massive trend of disruption for insurance products,” said Antoine Denoix (pictured), chief executive officer of AXA Global Parametrics.
The first parametric products have been around since the late-1990s, and were developed by commodities traders as well as energy companies. AXA entered the parametrics space in 2006, when it issued its first parametric insurance policy, done with the World Food Programme to cover droughts in Ethiopia. In 2014, a parametrics-focused team was formed within AXA Corporate Solutions, while the standalone entity known as AXA Global Parametrics was established in 2017 to focus solely on crafting and pricing index-based solutions.
To understand how parametric insurance works and its relevance in today’s world, you need to first understand climate changes and their impacts on entities, according to the AXA Global Parametrics experts.
“About seven out of nine economic sectors are actually weather sensitive, already now without even taking climate change into the picture,” said Karina Whalley, marketing and development manager at AXA Global Parametrics. “The vast range of different types of climate and weather risks include frost, excess rainfall, drought, flooding, and we’re using about 40-plus different weather parameters to create our indices. Every day we’re finding new data sources or we’re creating new indices for new types of peril, such as hail, [and] we’ve just done recently a wildfire [index] as well.
“With climate change, these kinds of impacts from weather are really going to become exacerbated. So far, we’re already seeing frequency of natural disasters increasing globally, so it’s five times more frequent than in 1970 to have weather anomalies and natural disasters, and on severity, we’re also seeing spikes in things like CAT 4 and CAT 5 cyclones – I think 2017’s hurricane season was a case in point.”
In the same vein, putting together a parametric solution involves a weather-based index.
“The first step in building a parametrics product [is determining] the correlation between the index and a drop of revenues or increase of costs for the customers,” explained Denoix, while the second step is to set a trigger for this index – taking a solar energy company as an example, the trigger could be set at minus-20% the average annual sunshine for a specific year. If this trigger, also known as the threshold value, is met, the insurance policy would pay out for the customer a pre-determined amount at the end of the day.
“It’s quite a revolution in that mindset because you do not rely any more on any loss assessment of physical damages – you get rid of that, in fact. As soon as you have a good fit between the index and the actual losses of a customer, you can be very creative with the way you use parametric products,” said Denoix.
An important benefit of using parametric insurance is speed – a major pain point for insurance customers is the time between when a claim is submitted and when they receive the payout. As a result of using a parametrics policy, the aftermath of a natural catastrophe can be lessened since governments and investors will know that claims will be paid soon after this disaster has occurred. These solutions are also cost-effective, globally available, crafted to each company and their unique risks – a ski lift in France can use a parametrics product that triggers payouts based on a lack of snowfall, for instance – and as soon as a correlation between losses and an index is established, coverage can be built to protect organisations against climate-related risks.
With blockchain technology, which will allow parametric triggers to be built into payment systems, meaning that payouts will become automatic and happen over a matter of seconds, as well as improvements in satellite imagery that have already taken place, the sky’s the limit for this emerging field of insurance.
Because of the progress made with the granularity of satellite imagery specifically, Denoix said, “Now, we are able to deal with drought, frost, [and] excessive precipitation to use satellite images to trigger the insurance payout, and it’s a key enabler to open new markets – for example, emerging markets in Africa or some parts of Asia.”
Now that some insurance companies have parametrics expertise, insurance professionals can offer these solutions to the market and address holes left behind by other insurance solutions.
“It’s simple – we need transparency and trust with the customer, and to solve key pain points,” said Denoix.