Parametric insurance could become more mainstream in the commercial sector and enable risk managers to address some of the limitations of traditional insurance – that’s according to a new report from Airmic in collaboration with Marsh and Swiss Re Corporate Solutions.
But what exactly is parametric insurance? We asked one of the report’s contributors, Steve Harry, risk finance consultant in Marsh’s Financial Solutions Group, for the rundown on everything risk managers need to know.
What is parametric insurance?
“Parametric insurance works using a clearly defined parameter – i.e. a metric or an index that is easy to determine,” according to Harry. That can be in terms of the trigger of the insurance, the payout, or both.
“Broadly, it’s an insurance program that is triggered, and/or paid very simply using an index rather than words.”
Currently, parametrics is mostly used in the reinsurance space around catastrophe risks, but some risk managers have started to use parametrics in the travel, retail and agricultural sectors, according to the report – and the insurance industry has its sights set on a much wider application in the future.
What are the benefits of a parametric policy?
Using parametrics, risk managers can look to insure risks that are difficult or even impossible to insure in the mass market. And while a complex insurance claim on a traditional policy can take a long time to adjust and be paid out, the clarity around parametric policies means claims are resolved much faster and without dispute.
“The way we would express it is that it improves liquidity,” said Harry. “Really what we are looking to do is mitigate the liquidity risk of a traditional insurance contract in these complex areas.”
As for whether a you should look to a parametric policy or a traditional one, that all depends on what you’re looking for.
“It’s about whether those features of the contract – fast payment, speedy adjustment, and a very easy-to-work-out scale of payment – appeal to the risk manager,” he added.
Where should risk managers start in looking at parametrics?
Insurance buyers looking at parametric solutions face a number of challenges and may need to acquire new skills, according to the report. The data demands of parametrics are different and, because the cover tends to be wider, it can be more expensive. Buyers need to start with a good understanding of their organization’s business model, and may need to do a significant amount of work early on.
“One of the things the Airmic paper picks up on is the idea that risk managers need to work internally a lot first to look for some data, because you need reliable, historic data on your index… and that can be quite hard to get in a reliable enough state to form a financial contract on,” Harry explained.
“For risk managers, taking the time to understand their firm’s ability to withstand future ‘shocks’ and gaining the support of the board are crucial first steps to incorporating parametric insurance solutions into their overall risk management strategy.”
What’s ahead for the parametric insurance market?
At present, there have been very few direct parametrics policies placed by insurers – but Harry says that could be set to change.
“We have definitely seen more enquiries over the last year,” he said. “The data and modelling is now so much better that it’s a real reason to be optimistic that some of these deals might take off.
“I also think buyers are now more sophisticated in the way that they look at their insurance, and they understand some of the limitations of a conventional insurance policy. Some people like the uncertainty that gives them, in that they can always argue about a policy contract, and other people like the certainty that an index-based product would give them.”
According to Airmic chair Paul Goulding, while parametrics is still a work in progress, it could well become mainstream in the future thanks to the promise of certainty of timing and hassle-free payment.
Georgina Wainwright, research and development manager at Airmic, added: “This is an area of insurance that has the potential to grow rapidly, both in terms of the extent of its application and the number of companies that use it. It can provide more options and ultimately ensure that insurance becomes a truly strategic purchase.”