Parametric triggers can expand the limits of insurability: Swiss Re

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Parametric triggers, coupled with increasingly granular data and technology, can “expand the limits of insurability” according to Swiss Re, especially when it comes to non-physical damage business interruption (NDBI).

Parametric triggerInnovation continues to deliver on new ways to mitigate risks, Swiss Re said in a recent report.

These innovations are enabling better management of risk, greater ability to transfer those risks, and even in some cases making the previously uninsurable insurable.

For global insurance and reinsurance players, investments in initiatives that can help to unlock new risk categories and classes of business are seen as key strategic priorities right now.

With some traditional areas of the insurance and reinsurance market now experiencing flatter rates, with smaller or more localised increases following losses, being early to new risk categories is absolutely key for the largest re/insurers in the world, like Swiss Re.

Hence the investment in data and analytics, as well as sensors and sensing, plus related data gathering and delivery technology, are all set to drive the ability to derive and define new parameters that are linked to an exposure or risk, so enabling the creation of new parametric triggers.

In its report, Swiss Re explained that the firm is seeing, “rising interest in parametric insurance products.”

Going onto explain, “Rapid technological progress, in particular digital transformation, is changing the nature of business. There has been a rise of new types of company and business model, for example in the sharing economy.

“Business has also transformed from being rich in physical assets to deriving more value from intangibles and services. These changes have seen a concurrent emergence of new and innovative insurance solutions, moving from asset and balance sheet covers, to protection for earnings and cash flow risks.”

Parametric insurance solutions fit these new areas of protection well, given the buyers of protection here are typically not looking for full indemnification, but rather for financial protection that buffers against volatility and uncertainty.

The expansion of risk has not just occurred in the high-tech world of the sharing economy and other new industry models, but it has also happened in areas such as commercial property where what is insurable has expanded from traditional property damage alone, to business interruption, contingent business interruption and now Swiss Re believes that non-physical damage business interruption (NDBI) is the next stage in this evolution.

Parametric triggers have already proved useful for creating new classes of hedging tools and insurance for contingent business interruption, where a parameter associated with one asset can be correlated and linked to a financial impact.

NDBI parametric triggers would allow that to be taken one step further, to deliver new insurance solutions that respond to the intangible and in an entirely new way, compared to traditional insurance and reinsurance.

Swiss Re explains this as, “With NDBI, the insured risk is detached from traditional asset-related property risk, as the cover protects earnings even when there is no physical damage at an insured’s or a third-party property.”

Examples of NDBI exposures could include electricity black-outs, strikes, blockades, a withdrawal of regulatory approval or product license, and even bankruptcy at a key supplier.

In addition, the increasingly digital world and digitalisation of business can create new NDBI risks, as cyber attacks, software errors, and internet access are all emerging examples of NDBI exposures as well.

“Events that cause NDBI can result in significant economic damage but traditionally, these have been difficult to insure or hedge. As exposures can vary in each case, there is no standard NDBI solution,” Swiss Re continued.

Adding that, “Moreover, the disconnect of NDBI risk from traditional property risk factors gives rise to asymmetric information and data availability issues, rendering traditional insurance covers inappropriate.”

This is where parametric triggers come in.

Swiss Re says that it believes, “parametric products can be used to expand the limits of insurability and facilitate NDBI covers,” just so long as the triggers and their design deliver on a number of important points.

Parametric triggers will be appropriate just so long as, “The solution provider is able to model the indices used for a trigger, the correlation of the exposure and the damage resulting from a triggering event, and there is a sufficiently high correlation of the index with an insured’s loss scenarios,” the reinsurance firm explained.

Swiss Re has already developed some products that deliver on the promise of parametric triggers for NDBI.

One example is a disaster relief add on for mortgages in Japan, that not only protects the mortgage holder but also the bank offering the mortgage as well.

Here, the trigger is the disaster event parameters and the mortgage holder can get repayment relief, protecting their ability to make payments but also the bank as well, in terms of providing greater continuity of cash-flow and financing after a catastrophe.

Another solution is a multi-year parametric index insurance policy covering earthquake shake, that pays out to policyholders such as retailers when earthquakes occur that would affect footfall and trading at retail sites, covering them against earnings volatility.

Another reason parametric triggers can help is in much faster claims payment and liquidity, of course. By delivering insurance solutions that pay-out quickly and in a transparent manner based on pre-defined indices or measurements of any input, the protection can be significantly more responsive to the buyers needs, compared to the lengthy claims process of some commercial insurance arrangements, especially around property risks.

Swiss Re sees parametric solutions as a key area of growth for commercial insurance, in particular covering non-physical damage business interruption risks.

“In our view, these are the next step in the evolution of covers for exposures that have been difficult to insure, such as cash flow and earnings volatility. In addition to pay-outs, a main benefit of NDBI solutions is that they improve the efficiency of risk transfer,” the company explained.

Also read:

Cost, efficiency, product & unbundling vital to protection gap initiatives.

Risk managers & C-Suite lack understanding of parametric risk transfer.

Parametric ILS “vital” to reduce protection gaps, increase resilience: Mark Carney, Bank of England.

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