In a world of changing risk, has the moment for parametric insurance arrived?

 “It’s an exciting time for parametric insurance. ART is like life; it only gets going after 30 years!” Those were the opening remarks from Rowan Douglas, Chief Executive Officer of Howden Climate Risk and Resilience. 

Douglas paid homage to the valuable role – going back centuries - of insurance, in finance and society. He said: “The big challenge is to move what we do into the wider economy, changing the world of risk.” 

That changing world of risk is no more evident that in the conversations surrounding the climate change debate which will be re-ignited at the COP conference in Baku, Azerbaijan in two weeks. Insurance solutions, which include parametric structures, will need to evolve and introduce new levels of innovation to embed resilience for individuals and firms concerned about a changing environment. 

Liquidity risks 

Insurance is again becoming part of mainstream conversations for capital markets and asset owners. It is seen as being a vital enabler for infrastructure projects, and to free up capital particularly as the complexity of modern-day supply chains poses liquidity risks. 

In his keynote address, Douglas referred to the steam boiler-driven carbon revolution which had a major impact on investors. Steam boilers were vital but kept blowing up. Hartford Steam Boiler company made them insurable which therefore meant they became investable. So, at that time in the 19th Century it was very much appreciated that insurance led the way to investability. 

“Insurance is a sub stack of the capital stack,” said Douglas, who mentioned that Benjamin Franklin was an insurer by profession. The urban “morphology” in the US was changed because of insurance, introducing more stringent rules and regulations in insurance which helped to allocate capital for resilience. Roosevelt’s New Deal in the 20th Century took this process a step further, with public private investment often being underpinned by insurance-type structures. 

Insurance bedrock 

From 1850-1950, insurers were the bedrock of the carbon transition. Douglas argued that the insurance market need to step up to the plate the same way – but at pace - in the next 5 years as economies transition into the net zero era along the lines framed by the Bank of England’s Sarah Breeden who has talked about how financial services firms in the UK can act as stewards in the move to a ‘net zero’ economy, designing climate scenarios. 

“Insurance will save the lives of hundreds of millions of people” concluded Douglas in the WTW auditorium while, outside the building, hundreds of climate change activists protested. 

The final message was optimistic: insurance should “Embrace the wider financial system and act as that safety valve. These are big forces we can surf and shape. Campaign for what we need to do to change the world.” 

Building resilience 

In the first panel discussion Building resilience to the most pressing threats, the long history of insurance providing resilience came to the fore as the speaker cited the influence of 1370s Italian insurers in Genoa, which invented the first indemnities. Insurance has long innovated. 

So, the question for the panellists in these sessions was “as we head into a soft market, how can parametric insurance compete and innovate? The drive to parametric insurance is because of its efficiency, the fact that it is cleaner in the way it responds to events, so it sits outside of the traditional insurance and reinsurance market.  

A parametric solution can pay claims in 1 or 2 weeks, not after 500 days as per the traditional insurance market. Parametric and traditional insurance complement each other. Parametric products “reduce basis risk” and are more transparent. Recent Florida windspeed triggers paid out in 10 days.  

Benefits for society 

A Parametric index is a “more objective measurement helping communities, individuals, governments to build resilience”, against a dangerous backdrop of food insecurity, disease, and little or no cash flow when disaster strikes 

The potential benefits to society of going down the Parametric route is huge. These indices could help developing nations where there is a lack of infrastructure, which is unsupported by traditional indemnity solutions, for example the lack of local loss adjusters on the ground. It could help entire nations and communities to make the leap to prosperity using parametric insurance in much the same that Africa embraced mobile phones to source micro insurance products. 

One exciting possibility mentioned was a potential role for “Business Interruption pre-event solutions”, with money going in advance to a disaster zone, before the event, though some underwriters on the panel were a bit nervous about the idea. 

Managing volatility in an uncertain world 

The panellists see growing demand in hospitality, leisure, transportation, energy, and agriculture. There have been advances in granular data to create better indices allied with creativity in new MGAs focusing on cyber. Insurance is seen to be at the heart of financing, moving capital around the globe. Insurance is: “the grease that gets the financing done.” 

Business Interruption triggers 

Risks affecting the supply chain are seen as ripe for insurance innovation with parametric solutions at the forefront of a new wave of innovation. The concept of connected risk was implicitly acknowledged when one panellist described how an earthquake affecting Taiwan would have a ripple effect on car makers in Europe. The solution would be a new type of CBI coverage, whereby if the suppliers are down, you could get a capital injection while waiting for the supplier to get up and running again 

Environment risks affecting the Marine market were also discussed, as periods of drought affecting river water levels are even now holding up cargo deliveries so could a parametric trigger help? 

The morning concluded with the closing statement that corporate clients will need parametric cyber products for BI, with structured solutions in captives. Parametric insurers will be asked to protect the captive, with captives ultimately hedging themselves against new types of risks.