The parametric insurance and risk transfer market is evolving rapidly and its ability to provide what are perceived as cleaner contract terms, as well as greater certainty, looks set to be increasingly attractive to alternative sources of reinsurance capital.
The parametric insurance marketplace is more than twenty year’s old. In fact the first parametric catastrophe bond we ever covered was right back in 1997 close to the beginning of the insurance-linked securities (ILS) market.
Insurance and reinsurance risk transfer arrangements had been structured on a parametric basis before that as well, but it is really only in the last few years that the rest of the market has begun to embrace parametric triggers more wholeheartedly, while technology has helped those triggers to become far more sophisticated.
As we explained in an article yesterday, the ILS market is on a flight to simplicity in some quarters, meaning that transparent contract terms and predictable payouts are seen as desirable by some investors.
Parametric risk transfer structures offer this added certainty and transparency, as well as having benefits when it comes to portfolio diversification for ILS fund managers and investors as well.
In a recent report, Alex Kaplan, Executive Vice President of the Alternative Risk team at global distributor and servicer of specialty insurance solutions AmWins Group Inc., explained succinctly why the focus on parametrics is increasing at this time and why investors backing insurance-linked securities (ILS) funds are attracted to these risks.
His company highlights the increasing sophistication of parametric structures and as a result their ability to better cover key risks.
At the same time, there is an increasing recognition that the traditional insurance product has its own gaps in coverage, as evidenced by the COVID-19 pandemic.
Sometimes those gaps can be covered using structures based on parametric triggers, leading to the potential for the design of entirely new risk transfer products.
Insurance and reinsurance market’s alike are attracted to parametric risk triggers, given their diversifying nature, the reduced administrative costs associated with them and faster, more transparent claims process.
AmWINS highlights that on top of this the “cleanness” of the risk, in parametric risk transfer structures, “is attractive to alternative capital markets by avoiding “trapped collateral” and lengthy loss developments.”
On top of this, MGA’s and insurtech start-ups are driving significant advancements in the use of data for constructing parametric triggers, leading to sometimes more successful and sustainable underwriting.
AmWINS expects that competition will increase in the parametric insurance and risk transfer space, as both the underwriting and modelling of parametric structures becomes increasingly standardised.
“We see more markets entering this space, more diversity in offerings, and faster product development,” explained Kaplan, of AmWINS’ Alternative Risk team.
“In a hardening property market, these structures begin to look more appealing from a coverage and pricing perspective.”
In 2021, AmWINS expects to see accelerating development speed and product accessibility in the parametric risk transfer space, leading to a decline in costs as well.
In addition, Kaplan said, “I anticipate that new pools of capital will choose to enter this space.”
Adding that, “The dramatic losses in the property industry over the last five years from wildfires and severe convective storms and the general need for new insurance solutions will drive demand.
“We are only scratching the surface of what is possible as new technologies are developed, the computational power of the industry increases, and the broad scale of data digitization continues. This will allow us to underwrite risks and offer solutions that were previously not possible.”
These advancements, combined with the predictability, transparency and greater certainty often available to underwriters of parametric products, are expected to drive the appetite of global reinsurance and ILS fund markets to assume risk structured on a parametric basis.
The upshot of this for the insurance-linked securities (ILS) space could be particularly interesting, as advancements in the sophistication of parametric triggers, at the same time as increased speed of development and a reduction in costs, could be just what is needed to attract more corporate risk transfer buyers to look to parametric ILS structures, such as catastrophe bonds.
Combining the increasing efficiency of parametric triggers, with the efficiency of capital markets funding of risk and the ILS manager business model, could make a compelling proposition for commercial risk transfer buyers to seriously look to the catastrophe bond market in greater numbers, driving more issuance and more of what many investors ultimately want to see in this space.