The Big Question: Is the parametric approach the solution to natural catastrophe challenges?

“The risk environment we face is increasingly complex and volatile, which only puts greater onus on transparency and the quality of data, whether from the perspective of insureds, brokers or underwriters.”

“Parametric solutions are an exciting area of product innovation, being pioneered across a range of classes of business, beyond their origins in extreme weather perils. But whatever the underlying risk, parametric products entirely rely on the certainty of quality, granular, reliable data.”

“I say this because in our business, we’re focused on giving underwriters the tools to analyse data, providing the intelligence to take better decisions. In the big picture, as that data-led underwriting improves, so parametric products will increasingly come into their own, becoming a more readily used risk transfer solution across the market.”

Ian Summers, Global Business Development Leader, AdvantageGo

Martin Hotz, Head Parametric Nat Cat, Swiss Re Corporate Solutions says he believes the role of parametric insurance can only increase as the world looks to tackle ever greater natural peril exposures.

Swiss Re’s research arm, the Swiss Re Institute, recently revealed that the insured costs of natural catastrophes in 2023 was $108 billion, meaning the costs of natural catastrophes to the industry has exceeded $100 billion in each of the past four years.

However, of more concern was the rise in the number of severe weather events which reached a record 142, with serious convective storms in the US and Europe driving the leap.

The study added the global protection gap between the insured losses and economic losses last year rose to 62% providing the market with the challenge of raising awareness at a time when risks are becoming more frequent.

“The benefits of parametric insurance for natural perils are already established,” Hotz explains. “At Swiss Re we have a global team within our corporate solutions operation which looks at parametric insurance looking at the approach we can take to major perils such as earthquake and windstorm alongside the growing exposures to secondary perils.

“We have seen the figures which were released in recent weeks and those totals are for a year which does not include what could be deemed as a standout event.”

Hotz adds: “We cannot ignore the fact that insured losses were less than half those of the total economic loss.”

The rise in urbanisation and the impact of climate change coupled with a population shift to areas which are classified as high risks areas will continue to test the market he says.

“There is a clear need for insurance cover for these events and that need highlights the benefits that parametric insurance can bring. That may be in areas which support the property covers, such as business interruption cover given the way parametric insurance can be constructed to deliver specific amounts of cover.”

Hotz says that Swiss Re Corporate Solutions was building an underwriting centre of excellence for parametric insurance to natural catastrophe risks more than five years ago.

“We have been working in parametric covers for many years and the size of the market has grown steadily,” he explains. “We look to work with the broker and the client to understand what works best.

“Given our experience in the market we are able to show solutions in action and clients are keen to understand how the product will respond.

“The core aspects of the policy remain the same but the advances that have been made that have increased the capabilities are significant. The engine might be the same, but we have added more cylinders.”

Given the greater complexity in the risk market Hotz says the certainty that can be delivered by parametric insurance is becoming increasingly attractive.

“The transparency around what is covered and how the policy will respond provides real clarity for the client,” he continues. “We are seeing clients which have increasing exposure to natural catastrophe risks and that provides opportunities.

“With more severe earthquake, windstorm and connective storm risks there are clients for whom traditional cover does not fully meet their needs.”

“The transparency of the product also delivers greater liquidity. We are seeing in the current market situations where clients are being left with higher retentions. They can either accept the risk or find sideways cover.”

With the public sector, including national governments, looking for broad protection for extreme weather risks the (re)insurance industry has the opportunity to look to public – private partnerships. The clarity that parametric insurance can bring with a specified trigger leading to an agreed response and payment is a solution that can suit both sides of the transaction.

“There is a higher degree of certainty and there is agreement on the level of event that will trigger the loss,” Hotz adds. “For an earthquake that may be the magnitude or the level of ground shaking and for a hurricane a designated wind speed.

“This delivers the security to the client in terms of when and how the policy will react and that transparency is a significant plus.

“However, with natural catastrophes there can be effects that no one can contemplate.”

“From a protection gap perspective, parametric insurance can help to attract capital into the sector,” Hotz explains. “For the capital market there are fewer variables in the transaction which adds to the ability to understand and calculate the risks.”

He says the growth in the market has been accompanied with the ability to put into place more sophisticated and specific triggers.

“The triggers provide a clarity of agreement between the underwriter and the client,” he explains. “We run risk models for a wide range of global scenarios to identify the potential risks and what we believe can be structured.

“We have more and better observational data that allows us to cover a broader range of perils in more specific ways which would not have been envisioned even a few years ago. It is an educational process between the broker, the client and ourselves to set the parameters.

“We can access quality third party data from recognised institutions such as the National Hurricane Centre or the US Geological Survey, as well as from specialised firms like Moody’s RMS, CoreLogic or Reask, which will resonate with the client.”