Parametric insurance is the solution to the re/insurance industry’s problem with intangible assets, according to Marcus Schmalbach, the chief executive officer of RYSKEX.
Schmalbach argues the traditional insurance market is failing in its core objective of protecting businesses against risk, with the growing importance of intangible assets in the global economy compounding the problem with every passing year.
“Examining the balance sheets of the S&P 500, some 83 percent of their value now stems from intangible assets, up from only 20 percent or so 40 years ago,” said Schmalbach.
Even in the relatively mature property market, there is a coverage gap of around $83 billion on property damage that the Swiss Re Institute calculated to be around $133 billion in 2019. When it comes to intangible assets, that coverage gap is considerably higher, said Schmalbach.
Intangible assets include a wide variety of items, such as service contracts, intellectual property, goodwill, software, trademarks, data, rights of use and other non-physical goods. “Unlike property or machinery, they are hard to classify and even harder to evaluate,” explained Schmalbach. “They are almost wholly uninsured because traditional indemnity-based insurance lacks a reliable methodology for calculating damage.”
The industry can take some comfort from the growth of the cyber insurance market, noted Schmalbach. “Data, being the new oil, is the underlying commodity for most of the intangible assets and the well from which they draw their value,” he said. “As a result, cyber insurance is one of the fastest growing product lines in the marketplace.”
Even in the cyber market, coverage is still miniscule compared with asset values, noted Schmalbach, though parametric triggers are increasingly being used in cyber products.
However, parametric insurance offers a neat solution to the intangible challenge and can bring insurance products for a range of intangible assets, including cyber, into the mainstream, he said.
Parametric triggers are well suited for this kind of insurance because they do not require a precise calculation of asset values. Instead, pay-outs are based on a clearly defined parametric trigger that is agreed between the insurer and the insured at the onset of the contract.
Schmalbach explained: “Parametric insurance is as simple as an if-then statement: if this, then pay that. All that is needed is a trigger and a pay-out mechanism.”
Parametric products have been around for at least a decade, but three new technologies are converging to propel these products forward, said Schmalbach.
Schmalbach said: “First, machine learning algorithms enable the construction of sophisticated triggers based on non-traditional data sets. Second, platform business models make the trading of risk friction free and the marketplace much more efficient at matching buyers and sellers. Third, distributed ledgers, based on blockchain technology, make pay-outs faster and more transparent, thus resolving some of the trust issues that restrain the purchase of traditional insurance.”
Schmalbach believes that a solution that combined all these features into a convergent trifecta will be enthusiastically received. And RYSKEX is currently developing just such a product.
Investors tend to be comfortable with parametric triggers, given they have often had some experience of them through their investments in things like equity options. So the increasing use of parametric triggers could help reinsurers unlock more alternative capital, said Schmalbach.
That could be a game-changer for the reinsurance industry: the Aon Reinsurance report 2020 estimated the global pool of reinsurer capital is $532 billion - a drop in the ocean compared to the $75 trillion global equity market, the $100 trillion global bond market, or the $700 trillion notional principal value of the global derivatives market.
Schmalbach argues capital markets and parametric products make natural bedfellows. This explains the growing interest in insurance linked securities (ILS), he said, which in 2019 grew to around $40 billion in total outstanding, with around a quarter of that issued that year alone.
“The reinsurance market is a paddling pool compared to the ocean of global capital,” said Schmalbach. “Parametric insurance, using ILS, is the friendly lifeguard who will usher risk from one to the other. Capital markets not only have much deeper pools, but also long familiarity with the underlying concepts of parametric triggers, since that is what drives derivative contracts, like stock and bond options.”
In the soon to be published whitepaper Heartbeat In The Fog: Parametric Insurance of Intangible Assets”, Axis Capital’s John Donald develops an interesting Dupont style model to analyse the growth of ILS relative to the burgeoning intangible asset base in corporate balance sheets, noted Schmalbach. “Though it is too early to come to a firm conclusion, it does at least signpost the way forward in this fast-developing new market,” he concluded.
RYSKEX, Marcus Schmalbach, Parametric