Parametric products will have role to play in closing protection gaps

There is a growing lobby among the insurance industry that believe the use of parametric insurance solutions will enable new risks to be covered in a way which will suit the individual and SME markets.

According to Munich Re, parametric insurance works by covering the probability of a predefined event happening, with policies paying out according to a pre-decided scheme instead of using a traditional claims adjustment process.

While there are several benefits to the use of parametric triggers within policies, there are still some significant hurdles that need to be overcome before such products are on the market to any great degree.

However, that is not to say there is no evidence that such schemes can work. A case in point is FloodFlash. The underwriting agency, backed by Munich Re, offers commercial businesses the ability to insure their premises for a fixed sum against a flood which hits an agreed level.

The company installs sensors at a predetermined height across various points in the insured property and should floodwater reach the sensor, FloodFlash is informed and will immediately pay the amount prearranged with the policyholder.

Traditionally, parametric covers have been the domain of the alternative risk transfer sector, often used for insuring severe weather events, or microinsurance schemes in areas where those who need insurance most can least afford it.

However, the rising sophistication of technology, the level of data the Internet of Things (IoT) can deliver, the coverage issues that have arisen during the Covid-19 pandemic and the need to find solutions to emerging risks has seen parametric solutions now being seriously considered.

Two risks that have been identified as potential new ground for parametric solutions are non-damage business interruption (BI) and cyber.

The pandemic brought the current approach to BI into sharper focus thanks to the FCA’s test case – subsequent calls for greater transparency around what is and isn’t insured within policy wordings suggest parametric solutions could be warmly received in this line of business.

Plus, there are those in the industry who believe SMEs in particular would benefit from a parametric cover that delivers a fixed payment should the agreed trigger be met.

Steve Harry, senior vice-president at Marsh Risk Analytics, who heads up the UK operations of the broker’s global Parametric Solutions Centre, said: “The main advantages [of parametric insurance policies] are the simplicity of the cover and the speed of payment.

“The issue with traditional insurance has long been that it is viewed as easy to buy but far more difficult to make a claim and receive a payment. There is an attraction for smaller firms and individuals to know the exact amount they can expect to receive should an event occur.”

‘Enormous potential’ for brokers

Brokers are alive to the potential around parametric covers.

Biba executive director Graeme Trudgill explained: “There is enormous potential for parametric insurance to continue to evolve in the UK. We have seen some products succeed already and we expect this sector to grow.

“Parametric insurance is already working well on certain larger global risks. Feedback that we have received from the Federation of Small Businesses in relation to the BI test case suggests that SMEs like the idea of having a simple parametric trigger to validate a claim and receive a speedy payment.”

However, Trudgill outlined “two key considerations” from Biba members around the use of parametric insurance.

This includes “the risk of insuring a fixed amount that may be lower than the full value [of the] risk”, as well as evaluating whether parametric policies are suitable “for the diverse types of insurance risk available”.

Trudgill continued: “Will some clients need the full range of insurer claims reinstatement services rather than just a simple payment? Brokers can work through these options with their clients and we expect the parametric model will continue to develop over time.”

Gathering the right data

Harry agreed that there are still issues with parametric insurance that need to be addressed.

He said: “By their nature, parametric solutions do not have the precision in terms of the payment compared to the actual loss.

“However, there are those who would be happy to be assured of the swift payment of a set amount [rather] then have to wait for a claim to be settled in the traditional way.”

The crux of the challenge with parametric cover, according to Harry, lies in being able to accurately price risks.

“The biggest change that will facilitate the use of parametric solutions in areas such as non-damage BI has been better access to data and enhanced levels of technology in the delivery of solutions,” he said.

“Where potential problems lie is around the ability to create an independent index on which insurers can price the risks.

“For weather events, there is a huge amount of independent information available which would allow insurers to set specific triggers for wind speed or flood height, for instance.

“If you take the example of non-damage BI for a retail firm, while the company might be able to provide data on their footfall each day or week, the insurer may well be reluctant to base any cover or pricing on data which is not from a third party. It may require the creation of new index which can be independently verified.”

Harry added that parametric solutions also require a scientific approach to pricing, which would negate the rating competition that is seen in the traditional insurance market.

“Insurers are used to the aggregation risk, so they are able to create parametric solutions if they have the data and an index on which to base it,” he said.

Harry also noted that any parametric cover would still be subject to principles of indemnity.

“You could not look to secure a payment to a level which clearly exceeds the value of any loss you may suffer,” he explained.

Although the industry is still ironing out potential parametric problems, Harry is “very optimistic as to the potential for the use of parametric solutions in areas such as BI and cyber”.

He said: “There is likely to be new solutions offered to the market but it will require collaboration between brokers and insurers to create products that will meet the challenges of new risks and rising demand.”