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Sep 2021

Climate change, contracting balance sheets & continued pandemic uncertainty - time for a next generation insurance solution

Source: Asia Insurance Review | Aug 2021

Robert Drysdale
As corporate budgets and market capacity tighten amidst mounting year-after-year extreme weather losses and continued uncertainty from the on-going COVID-19 crisis, parametric insurance is gaining ground as a preferred alternative to traditional insurance products.  An increasing number of brokers and their clients are judging parametric products to be more relevant to their needs due to price, certainty and assurance of what is covered - the full spectrum of financial consequences resulting from Nat CAT and climate exposures. Descartes Insurance Asia’s Mr Robert Drysdale explains why.
 
 
As a region, Asia is more exposed to natural catastrophes and extreme weather events than others.Whilst some Nat CAT activity was comparatively less than the climatological average last year, we still witnessed total economic losses of $26bn from Pacific tropical cyclones alone. This included typhoon Goni (typhoon Rolly) in the Philippines, and typhoon Amphan which impacted India, Bangladesh and Sri Lanka. Droughts in China and Vietnam at the start of 2020 were also followed by extensive flooding throughout the region, impacting 19 countries with total losses exceeding $55bn.
 
We are again witnessing historic flash floods in 2021 with the events in China and India this summer. After two years as the lead bearer of Nat CAT loss in the region, Japan also sustained significant economic damage of $8.5bn in 2020 due to flood, namely in the Kyushu Islands. Wildfires and other extreme weather (including major hail events in Australia), all rounded out a recorded total of $102bn in Nat CAT-driven economic losses in the region last year. Of these losses, it is sobering to note that only around 12% are reported to be insured.
 
How it works
 
Unlike traditional insurance, which relies on lengthy loss-adjustment procedures, parametric insurance pays out when a predefined event (i.e. flood, cyclone, earthquake, etc.) occurs as measured by a specified parameter or index such as rainfall, windspeed or peak ground acceleration. Driven by objective data and real-time monitoring from ground-based sensor technologies, radar, and satellite imagery, parametric insurance provides a means to guarantee liquidity via swift and direct pay-out, following a qualifying event. This new generation of products complements or replaces traditional insurance at a more affordable premium that fits within contracting budgets, not on-top. With no on-the-ground loss adjustment required, a parametric cover keeps cost low while offering precise protection. 
 
Nat CAT covered with full certainty
The rise in exclusionary language used in traditional policy wordings as a result of the pandemic and market hardening have brought unease and frayed trust among insureds. Comparatively, parametric policies and their straightforward structure provide unveiled transparency that rebuilds confidence for clients in ‘what they see is what they get’. This is core to the value proposition of parametric insurance - the ability to increase the certainty between a loss event taking place and a pay-out being made, quickly, accurately and without friction costs.
 
Wider coverage with reduced basis risk for buyers
The traditional principle of insuring against a factory catching fire and its subsequent loss of output as business interruption (BI) until the factory is repaired is no longer fit for purpose. The evolving operating models of businesses place increased importance on their intangible values - such as consumer attraction or revenue – which now account for a greater proportion of overall value than ever before. Parametric insurance is more effective at covering these exposures as there is no property damage trigger for BI claims, including in cases of indirect losses of revenue, contingent BI and additional costs of working.
 
A decade ago in Japan, retail groups saw their revenue severely impacted following the Tohoku earthquake and tsunami. Yet in the absence of direct material damage to the storefronts only a minor fraction of this loss was covered by traditional insurance. Likewise, the exceptional market demand currently being experienced by the semiconductor industry illustrates the need for a new approach to BI. Whereas traditional policies pay based on the average revenue of a company, in a year with supply shortages the actual loss could be considerably higher. The flexibility of a parametric cover enables the client to recover their true exposure, customised to market conditions and their individual needs.
 
Game-changing speed of payment
Unlike traditional covers where BI elements in particular can take an average of 18 months or more to be settled, parametric claims are paid in the same accounting year as the loss, often even just days following the event. This swift liquidity reduces volatility of the insured’s balance sheet, with loss and receivables both occurring in the same accounting period. Receiving revenue as if operations had continued as normal also supports the business in retaining staff and paying operational and supply chain costs seamlessly.
 
Case study – Covering traditional property and BI exclusions
 
Problem: Following typhoon Hato in 2017, a large resort suffered extensive losses that were excluded from its traditional property policy. These losses included expensive landscaping and fixings, as well as intangibles such as loss of attractiveness to tourists not wanting to visit an area that had just suffered a Nat CAT event. A portion of the client’s traditional BI claims went unpaid due to disputes over whether guests decided not to go to that specific resort due to property damage or avoided the entire city due to loss of attractiveness following the typhoon.
 
Solution: The straightforward structure of a parametric policy does not allow for discrimination against claims payments based on BI cause, nor does it require trigger by direct property damage. Instead, parametric coverage can be extended to financial consequences of all nature from Nat CAT impacts.
 
Reduced cost through the use of data
Ultimately, cost is usually a – if not ‘the’ – key factor in decision making.
 
By making better use of technology parametric insurance can cut administrative costs and make products more affordable. Allowing infinite customisation, parametric structures can be made to match a wide array of budgets and exposure means. This is important regardless, but even more so in the current environment where many insureds have (and continue) to suffer financially from the pandemic. All of which is compounded by the market hardening in the last couple of years.
 
An advanced approach to modelling risk enables coverage for ‘uninsurable’ exposures
Throughout Asian markets we see capacity continuing to diminish for some assets and risks carriers consider tricky to insure or uninsurable due to their frequency or characteristics. This is especially true for natural hazards and extreme weather exposures like wind, solar and rainfall yield volatility. It is also the case for assets such as underground networks, offshore and coastal properties, overhead transmission and distribution lines, transportation networks and others.
 
Loss-stricken accounts are much harder to place in the traditional market due to the methodology used by traditional insurers to price the risk, which is heavily weighted on historical losses. Whereas the parametric approach models the underlying risk (e.g. earthquake or flood) of an insured site and provides flexible calibration to historical loss data, risk appetite and any mitigation measures put in place by the client. The use of advanced technology combined with this forward-looking approach means that parametric insurance can extend to new industries that are rapidly developing in remote areas of the region without historical loss records, such as solar plants or offshore wind farms.
 
With a growing and extensive product offering against all Nat CAT perils, parametric insurance provides a means to supersede gaps in the traditional marketplace and better protect Asian markets and businesses against climate change. A 
 
Mr Robert Drysdale is head of Southeast Asia with Descartes Insurance Asia.
 
 
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