Parametric solutions: an important financial tool to close the protection gap

Insurance is rarely a one-size-fits-all offering. A client will approach an insurer, wanting to be covered for certain eventualities. The insurer will look at them closely, assess a number of different models and metrics, and do its best to come up with a figure and policy that best represents the client’s risk profile.

But there are some rare beasts within the sector that do not follow this path entirely. One of these is a parametric solution. Panay Koulovasilopoulos, senior international property underwriter at Hiscox Re & ILS, came to the Re/insurance Lounge, the on-demand platform for interviews and panel discussions with industry leaders, to explain how it all works.

Unlike traditional insurance policies that indemnify holders for the loss they suffer, parametric solutions pay out predetermined amounts if a certain event comes to pass, Koulovasilopoulos explained.

“A parametric solution doesn’t necessarily pay for the exact loss suffered. The amount paid is predetermined based on some sort of measure,” he said.

Common triggers for parametric products include cyclones, earthquakes, floods, epidemics and other natural and anthropogenic hazards.

Parametric solutions have a distinct advantage over other policies. “They speed up payouts so you are not dealing with loss adjusters. Once the event has happened, that’s when you get the payout,” he said.

Complex situations and collaboration

Despite the differences between indemnity and parametric-based products, the underwriting and analysis works in much the same way.

“However, there are complex situations where more validation work needs to be done to ensure the parametric policy reduces what’s called the ‘basis risk’.

“Basis risk is the difference between expectation and reality. If we use the example of a car, the damage might be £935, but the policy may pay only £900. That difference is the basis risk,” Koulovasilopoulos explained.

Parametric solutions are sold to clients of all sizes, from individuals to regional—and even national—governments. Of the latter, Koulovasilopoulos said: “Governments buy policies for earthquakes, cyclones, and excess rainfall.

“The government would then have resources with which it could protect public assets and support emergency response costs.”

Data is key, says Koulovasilopoulos, to this growing segment. “The type of data I’m talking about here is satellite information. Agriculture is an important industry in the developing world, and we now have satellite images with high levels of resolution. We can use that data to design parametric solutions in the developing world, which just wasn’t possible a few years ago, either because the datasets were too short or because it was too expensive,” he said.

2021 has brought numerous adverse weather events, the frequency of which seems to be increasing with each passing year. Koulovasilopoulos spoke about the challenges this poses to the industry.

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“Climate change is undeniable and there’s increasing evidence about its effects on the intensity and frequency of various natural hazards,” he said.

“What this means is that the past is not necessarily the best guide in terms of how often these events happen.”

It is an area the industry is closely monitoring and investigating.

“We need help to contextualise these losses and these events. A natural hazard doesn’t necessarily mean a disaster. We’re trying to understand the science and frequency and intensity of these events in order to give the best advice.

“If we’re just using the past to try to anticipate the future in a changing environment, it may mean that we don’t have the right solution or strategy in place,” he explained.

Koulovasilopoulos feels that the industry has more to offer than just coming in after the fact. With its knowledge and its resources, the sector is able to help and advise on prevention and mitigation, rather than simply paying out after the event.

“We can give advice to people on how to reduce their premiums,” he said. “That could be things such as telling them to irrigate crops or giving them advice on what to plant.

“We can also help farmers, through that advice, to improve the income they get from selling their crops. Giving advice reduces the risk, and reducing the risk can reduce the premium.”

Closing the protection gap that exists is not an easy task, however, and developing parametric solutions must be a collaborative effort, Koulovasilopoulos concluded.

“The reinsurance industry is pooling its resources together,” he explained. “No one person in the industry—and no one industry—can do this alone.

“A lot of factors are proving to be obstructions and creating a protection gap, and we need inter-industry collaboration to be able to close it, so this is working with governments, the reinsurance industry, charities and non-governmental organisations on the ground.”

To view the full Re/insurance Lounge session click here