Parametric ILS can narrow corporate protection gap: Dr. Alan Punter

by Artemis on December 22, 2016

The utilisation of parametric structured insurance-linked securities (ILS) solutions to protect corporations against the impacts of natural disasters has the potential to grow, providing effective coverage where conventional insurance and reinsurance markets have perhaps failed to do so, according to Dr. Alan Punter.

Mind the Gap sign (Source: Autoprotect)For corporations the impacts of catastrophe events can be far-reaching, varied and lasting, ranging from the tangible such as property damage, to the intangible and less direct, such as damaging reputation and the ability to launch products, ability to participate in M&A, and similar.

In a recent article by Dr. Alan Punter, Affiliate, Centre for Risk Studies, Judge Business School, University of Cambridge, the benefits of using a parametric structured ILS solution to close the corporate protection gap was noted.

Due to a complete lack of, or inadequate and ineffective supply of relevant insurance and reinsurance products, in part driven by the broad impacts catastrophe-related losses can have on corporations, Dr. Punter underlines a need for solutions that cover “difficult to insure risks.”

Such exposures may not be covered by conventional insurance, and where this is the case, indemnity structured insurance can take months, and even years to payout.

“One approach to closing this protection gap is through the use of contracts with parametric triggers, as have been used in the catastrophe bond space,” said Dr. Punter.

“Contracts with parametric triggers offer a possible approach to covering some of those difficult-to-insure risks – going beyond the specified perils and indemnity settlement constraints of conventional insurance – and going some way towards closing the protection gap,” he continued.

To date, and as shown by the Artemis Deal Directory, a number of corporations have utilised the ILS and catastrophe bond space to protect against the direct impacts of natural disasters, such as earthquakes and storms, and also more indirect risks, like event cancellation and operational risks.

A significant majority of corporate catastrophe bond issuance has utilised a parametric trigger, although a few have used an indemnity trigger structure.

Based on predefined risk parameters, such as a hurricane of a certain strength passing through a predetermined region, a transaction that features a parametric trigger can enable rapid payout post-event, as opposed to an indemnity structure that covers actual losses experienced from the event, which, can sometimes take years to be resolved.

An example of the speedy payout that a parametric ILS solution supports can be seen with the CCRIF SPC, a catastrophe risk insurance facility that protects member countries in the Caribbean, following the recent impact of hurricane Matthew.

The parametric catastrophe insurance facility paid out all $29.2 million of claims from hurricane Matthew in under 14 days, highlighting the benefit of such a mechanisms, as countries impacted by natural catastrophes, as is the case with corporations, likely need post-event funding as fast as possible.

“The benefit for the corporation securing cover under a catastrophe bond is that a prompt cash recovery of a known amount determined solely by the parametric formula may be considerably preferable to an uncertain (and sometimes partial, after legal fees, etc.) payment of an indemnity amount, likely not received until some years after the event.

“This is particularly so if the parametric structure can be calibrated to more closely match the full economic or business cost of the event than is achievable under conventional named perils and indemnity insurance coverage,” said Dr. Punter.

As noted, catastrophe bonds have been used by corporations in the past, but the scope for such transactions to be utilised more broadly and for a wider range of risks is apparent and the parametric trigger is an ideal way for a corporation to secure predictable disaster risk insurance that pays out precisely when impactful events occur.

Interestingly, Universal Insurance Holdings recently purchased a parametric catastrophe coverage for itself, calling it insurance (for an insurer) rather than reinsurance which is encouraging. It’s important that parametric triggered coverage is viewed for its benefits, of being a rapid paying source of insurance coverage for corporations, governments or other direct buyers, insurers and indeed reinsurers alike.

It will be interesting to see if more corporations look to the ILS market to find solutions that adequately and effectively address both the direct and indirect impacts of catastrophe events in 2017, and beyond.

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