Parametric insurance grows in importance for captives
Parametric insurance is growing in popularity in the captive space, but must be used correctly when considering the overall insurance needs of a captive.
In a session at the Cayman Captive Conference 2022 Eddie Brooks, associate director of Alternative Risk Transfer Solutions at WTW, looked at how index-based, or parametric, insurance has emerged over the past two decades as a risk transfer mechanism with particular application to emerging risks resulting from the climate and nature emergencies.
Parametrics first reached scale in the global south where traditional insurance has either not penetrated or has left large protection gaps. Now extensively tested and piloted, parametric structures are increasingly being deployed to manage climate and other disaster risk in the global north and across both public and private sectors, said Brooks.
The solution may not be a replacement for indemnity insurance, but parametric insurance has proven to be applicable in many situations where indemnity coverage is not. It pays out quickly via a transparent and objective loss calculation process, which has made it a good fit for financing emergency response costs for public entities and governments.
It can also provide something akin to business interruption coverage for natural assets, which enables finances to flow to urgent rehabilitation activities, for example, on coral reefs.
This ability has enabled faster and more complete restoration of ecosystems, which in turn support important economic activities such as fishing and tourism, as well as providing coastal protection.
Parametrics can also be used to protect debt repayments for a loan, the servicing of which might be stressed by the impacts of a natural disaster.
Brooks emphasised that the protection gap is large and that losses are getting bigger. As the world’s population grows, people are moving to areas that were uninhabited 100 years ago, meaning natural catastrophes are being recorded in more places.
He said that traditional insurance has limitations with longer waiting times and instances where claims may not be paid when damage is not direct. However, parametric solutions are different because they focus on severity, not the damage or loss at the insured location.
Brooks said that the advantages of parametric insurance were many, including flexibility, a simple structure, speed of settlement and simple loss certification. There are also no restrictions on use of funds with parametrics and they offer stable premiums that are less reactive to property market trends.
However, there are challenges, which include making sure that the correct index is selected, defining basis risk, how it fits alongside traditional insurance, the perception that parametric solutions are expensive and end user/regulator familiarity.