Parametric triggers can ensure business interruption recovery: Marsh

by Artemis on March 3, 2015

Businesses looking to protect themselves from property damage or business interruption due to natural disasters or weather events should look to alternative risk transfer structures and parametric triggers to ensure a recovery can be made, according to Marsh.

Marsh, the insurance and reinsurance broking powerhouse said that property damage and business interruption policies can often leave companies without cover in the event of what it terms a ‘wide area damage’ event, a catastrophe event impacting large areas that can cause significant disruption to supply chains.

“The devastation caused by natural catastrophe events remains the worst loss scenario facing many businesses. This is due to the increased exposure to natural hazards in today’s global marketplace, both directly and indirectly (through global supply chains or an international customer base),” Marsh explains.

As a result businesses, especially large global corporations with vast and interconnected supply chains, are at risk of serious financial impact in the event of large catastrophes and severe weather events around the world.

Often the business interruption and property damage insurance cover that companies have in force is insufficient, or simply not responsive to catastrophe and weather events in the way that they need. Businesses need a rapid payout very quickly after catastrophe events occur, in order to allow them to make adjustments to their supply chains and to recover more quickly.

Marsh continues; “No one is safe from natural catastrophe events, but the situation is intensified due to the uncertainty around cover provided by traditional policies.”

“One issue is in relation to sufficiency of limits — frequently, it is insurers that dictate the limits available (rather than the insured determining the limits that are required) — the other, and more fundamental, issue is the doubt over the effectiveness of coverage.”

Marsh notes that in many areas of the world the bulk of any natural catastrophe or weather loss is uninsured. “There are many reasons for such a shortfall, including conscious decisions not to insure, or industry standard exclusions,” the broker explains.

There is also the unknowns within a global supply chain that are often not risk managed effectively, or completely missed as potential threats, but which can result in an exacerbated financial loss in the event of wide area damage events.

“Emerging risks can also be to blame, for which no insurance has yet been sought (for example,
interruptions caused by natural catastrophe events that affect the suppliers of suppliers hidden in the chain),” Marsh continued.

Many business interruption insurance policies cover physical damage as a consequence of an event, rather than losses suffered as a consequence of an event. Businesses and corporations often don’t realise this nuance and can end up attempting to make claims for BI which their insurer will refuse to allow them to recover.

Ensuring that a recovery can be made, or payout received, is therefore vital for these big businesses and Marsh suggests that one possible way to ensure that an insurance program is responsive to catastrophes and weather events is to leverage alternative risk transfer techniques.

Specifically Marsh notes that parametric insurance policies could be the answer for many businesses, that are looking for a responsive source of protection for their supply chain and to protect against business interruption losses.

Marsh explains; “Planning is therefore essential, and loss scenario analysis (including insurers) is vital to understand how your PD/BI policy will react, and whether your limits are sufficient. If the unwanted answer from insurers comes — that cover for wide area damage is not included — then alternative risk transfer solutions, such as parametric trigger policies, can be considered.”

Parametric triggers have been used in insurance, reinsurance and the catastrophe bond market for many years and provide a way to make an insurance policy that pays out on the occurrence of a catastrophe or weather event that meets specified parameters.

So as long as the policy is designed to match the exposures that companies fear the most, a parametric trigger structure is perhaps the best suited as a way to boost property damage and business interruption protection (covering gaps in limits from traditional insurance coverage), or to ensure that at least something responds to your financial needs when the worst catastrophes strike.

Marsh also notes that in many emerging or developing regions of the world, a lack of reinsurance capacity makes insurance coverage harder to come by and exacerbates business interruption claims for globally interconnected supply chains.

Again the use of alternatives could help. The capital markets and insurance-linked securities (ILS) specialists have capacity that can be put to work for this, providing risk transfer directly to corporations in the form of parametric covers and even parametric catastrophe bonds. This could help to ensure that large corporations can make a claim and recover funds when the largest catastrophe events occur.

The topic of corporate cat bonds typically revolves around the use of parametric triggers. They are perfectly suited to providing a predictable source of risk transfer and insurance capacity to large global corporations at the time when they need it most.

The contingent nature of a corporate cat bond means that it only pays out when a corporation needs it most and as long as the trigger is well designed and structured it should be possible to ensure that is as a response to the natural catastrophe events which can most hurt the company.

The ILS market has both the appetite and the means to respond to large global corporations needs for parametric insurance and risk transfer solutions to cover natural disaster and weather events. It just needs corporations to take the step of analysing and uncovering the gaps in their traditional coverage, to find out where parametric structures may be the perfect fit.

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