If you’re concerned about rising insurance costs in Florida or California, take a moment to consider the challenges faced by earthquake survivors in Turkey or flood victims in Pakistan. Unlike most homeowners in developed countries, those in the developing world often cannot obtain natural-catastrophe insurance, also known as “natcat” in the industry, regardless of the price. This is a significant issue, especially as climate change leads to more frequent and severe calamities.
Thankfully, organizations like the World Bank and the United Nations have been providing substantial relief to these less fortunate disaster areas. In 2021 alone, they allocated an impressive $71 billion, according to the Centre for Disaster Protection. However, much of this funding is essentially “money they find in the back of the sofa,” as aptly described by Centre director Daniel Clarke. It is often distributed on an ad hoc basis, resulting in costly delays and political conflicts.
Fortunately, there is a better way forward. Enter parametric insurance—an innovative solution that offers great promise. Unlike conventional indemnity policies, which rely on time-consuming assessments of damage after the fact, parametric policies pay out a predetermined amount automatically when specific triggers, agreed upon in advance, are met. These triggers can range from tremor strength in an earthquake-prone area to wind speed or tidal surge in a floodplain.
Clarke emphasizes that despite climate change, many of these risks can still be accurately modeled. The simplicity of this approach expedites the settlement process and, ideally, reduces costs by bypassing the need for extensive involvement from adjusters and attorneys. This swift resolution is particularly attractive to governments in need of immediate funds for disaster relief. Additionally, insurers and reinsurers grappling with mounting natcat losses worldwide are finding parametric insurance increasingly appealing.
“We are conveying the message that this is a growing and profitable line of business,” asserts Antoine Bavandi, head of climate resilience solutions at reinsurance broker Gallagher Re.
As evidence of its success, payouts from parametric policies have multiplied by a staggering factor of 15 between 2017 and 2021. However, the total amount paid out is still relatively modest at $1.9 billion, according to the Centre for Disaster Protection.
In conclusion, parametric insurance offers an innovative solution to the challenges faced by homeowners in disaster-prone regions. By providing a streamlined approach to payouts and cutting unnecessary red tape, it has proven to be a valuable tool in ensuring faster relief for those affected by natural disasters. Furthermore, as the demand for such insurance continues to grow, it presents significant opportunities for insurers and reinsurers to make a positive impact while also driving profitability.
The Growing Trend of Parametric Insurance
In the aftermath of Morocco’s devastating earthquake last September, the emerging field of parametric insurance has gained significant attention. The earthquake, with a magnitude of 6.8, caused widespread damage in the Marrakesh region. Gallagher Re took the initiative and organized a $275 million parametric policy with a trigger of 5.0. Within just three weeks, the policy paid out, providing critical emergency response to the most vulnerable populations.
While this payout only covered a small fraction of the overall costs, estimated at no more than 15%, it played a crucial role in preventing further detrimental effects on people’s livelihoods. Parametric sovereign insurance is slowly gaining traction in the complex worlds of official donors and global climate diplomacy. Countries like Germany and the United Kingdom have already set the stage by allocating a portion of their foreign aid budget to disaster insurance premiums.
Last year’s COP 27 environmental summit resulted in the establishment of a “loss and damage” fund for climate-affected countries. This fund includes up to $400 million dedicated to insurance premiums. With COP 28 scheduled for November 30th in Dubai, there may be additional contributions to this cause.
Despite its potential, parametric insurance is not suitable for all types of coverage. It may not be the best choice for insuring personal assets like beach houses or wooded retreats. Policy triggers can be reached without any actual damage, leading to windfall profits for the policyholders. On the other hand, insured individuals must also consider the possibility of damages falling outside the pre-agreed triggers, which would result in unpaid claims.
Nevertheless, parametric insurance can still be a valuable component of coverage for entities with complex insurance needs, even in highly developed markets like the United States. Andrew Provines, an actuary based in New Jersey, emphasizes that parametric insurance can fill gaps in traditional indemnity insurance and is currently one of the most discussed topics in the industry.