Parametric insurance is predicted to generate nearly US$30bn per year by 2031. Ned Holmes looks at the impact it may have on the captive insurance industry, and why huge growth is expected
Parametric insurance has become an established part of the captive lexicon in recent years – a regular talking point at captive conferences and, increasingly, in board rooms.
While traditional insurance functions by indemnifying the actual losses sustained by a policyholder during an event, parametric insurance is linked to predetermined index-based triggers that lead to pre-agreed payouts.
If the index threshold is reached (a certain wind speed for hurricane cover or a length of downtime in cyber cover, for example) then the policyholder receives the payout – whether or not the actual losses are sustained.
A hot topic
The captive industry may have been late adopters, indeed the structures have been utilised elsewhere since the 1990s, but there is now a growing acceptance of the three-fold advantages these solutions can offer.
This includes certainty, (as the pay out triggers are predetermined and index based), speed, (as it removes the need for a lengthy loss adjustment process), and cost efficiency, (as there is no requirement to employ technical specialists like claims managers and attorneys to assess actual losses).
Marcus Schmalbach, CEO of RYSKEX, believes that parametric solutions are “a great thing for a captive manager to have in their toolkit” and predicts we will see them used much more frequently in the industry in the next decade.
“Parametrics is not adopted by everyone, but I see that the big brokers are working hard on adopting these solutions.
The new thing always becomes popular as soon as the clients need it, and we have the clients’ need because the markets have a lack of capacity. We needed to change our strategy and our indemnity coverages into parametrics.
“In five years time, we won’t be talking about it as something new, but as an established solution.”
“This is an area that is growing,” notes Jan Bachmann, head of innovative risk solutions EMEA, director at Swiss Re Corporate Solutions. “In a couple of years, buying parametric for a captive will be a normal business, but there is still a way to go.”
Parametric boom
It’s not just in the captive market where a parametric boom is expected. Swiss Re has predicted that the parametric insurance industry could generate nearly US$30 billion p/a by 2031 – up from $11.7 billion in 2021. As Swiss Re’s Bachmann says: “The numbers are expected to be significant. Why? Because it’s more than just what has been covered in the past by traditional insurance. You can insure more on a parametric basis due to the flexibility of the covers.
“It all started with natural catastrophes 30 years ago, when Swiss Re sold the first parametric covers for earthquakes and wind perils. Initially, it was only about natural perils but this principle of systemically looking for parameters on which the client depends, can also be applied to non-natural catastrophe risks.”
He adds: “It’s a useful tool for non-physical risks. As an example, a terror attack may cause loss of attraction in certain areas – people stop going there because it has become dangerous. There is no physical loss per se, but it could impact the revenue stream of the client because people will stop coming.
“There are plenty of ways to track it – such as airport data, lack of footfall or attraction, mobile data, credit card usage – and a difference from the average could expose the client to a loss-making situation.”
The hard market
A key factor in the predicted growth of parametrics is the current market condition.
“It’s because it’s a hard market that we need to get capacity and parametric is the only way the capital market understands to assist,” adds RYSKEX’s Schmalbach. “With insurance-linked funds, for example, we need a lot of capacity but they do not understand or do not like indemnity, so parametrics are also an opportunity to find capacity in the capital market.
“There’s momentum. It’s a new way of underwriting lines to help address systemic risks, such as hurricanes and floods. A lot of insurtechs are coming into the market that don’t offer any indemnity solutions and are just focusing on parametrics as a way to help out companies with climate change or pandemic risk. It’s the new boys in town that offer it. There is need and then you create a market. This is happening right now because of the hard market.”
Nils Ossenbrink, managing partner, head of distribution and products at Twelve Capital, offers a capital market perspective. He says parametric insurance could be a way of consolidating the mismatch of investors’ demands and the demand for reinsurance capital as it offers more clarity in terms of expected pay-outs. After an event, the size of the loss is known which can be beneficial from a structure perspective.
Ossenbrink notes that the industry is currently confronted with very high rates. The insurance industry is calling it a ‘hard market’ offering interesting opportunities to investors. Elevated rates are an indication of a lack of capital, which is also a result of the growing number of medium-sized, partly climate change-induced natural catastrophe disasters.
“We have clearly seen what climate change means costwise in recent years, and even this is going to increase,” he explains. “Institutional insurance-linked securities (ILS) investors had to face issues, for example: trapped collateral, side pockets, intransparency — all clearly below return expectations.
“These underlying issues cannot be solved by parametric solutions, but if the risks are structured in the proper manner, parametric solutions can support closing the global protection gap.”
Ossenbrink also believes that the growth in the catastrophe bond market hints that the predictions for the parametric industry may be on the money. He says: “The cat bond market has grown to around $38 billion, up from $5/6 billion in 2002, and from $11/12 billion between 2008 and 2012 — so it more than tripled in the last 10 years.
“From our point of view, it would be realistic to project that the parametric industry could grow to $30 billion if the relevant structures are available.”
New solutions for new risks
Natural catastrophe-related perils are the number one risk covered by parametric insurance and will continue to be so for some time. However, there is a growing confidence that the structures can be used elsewhere as well. In some places that is already the case.
“There are interesting solutions by start-ups and incumbents from the reinsurance and traditional insurance space where they use parametric for cyber and pandemic coverage,” says RYSKEX’s Schmalbach on the topic of emerging coverages.
“Wherever you need new solutions when new underwriting comes in, or new perils come to the market, you see a lot of companies that want to seek new ways and adapt new solutions for those new perils.
“Intangible assets is a currently underdeveloped market where I see parametric as a good fit. It’s a very important part of a company’s balance sheet. There aren’t too many coverage lines that already exist, but I think it could fit perfectly with parametric as it could be linked to stock price.
“It’s something interesting for captives to consider: to get new lines of underwriting within the captive. It’s an important market for the reinsurers themselves as well.”
Twelve Capital’s Ossenbrink highlights business interruption, cyber or casualty as other ILS areas of interest beyond natural catastrophe.
“We will likely see developments in business interruption. We may also see cyber risk connected with business interruption as well as an increasing demand from insurance companies to transfer casualty risks to financial markets,” he suggests.
“However, the capital market is still not fully comfortable with cyber risks yet. This means that in terms of perils covered by parametric, the focus is still likely to be natural catastrophe-related issues, which are generally well-modelled and known.”
Swiss Re’s Bachmann also emphasises the opportunity for other parametric solutions but warns that many of the new risks that the policies might cover in the future are not known yet.
“They’re usually the black swans – we may not know them today, but they might have a big impact tomorrow. In an emerging risk landscape, parametric can facilitate the response to a loss situation and speed up the claim payment.
He adds: “There are some good examples where parametric is still in its early stages, such as cyber or liability risks, but there is also some promising potential in these fields.”
Industry 4.0 and AI
Looking ahead to the future of captive insurance, artificial intelligence (AI) and the digitisation of the industry are two topics that are impossible to ignore.
“AI is going to affect many industries including the insurance industry,” says Twelve Capital’s Ossenbrink.
“The way of modelling risks will change in the coming years, whereas speed will increase. The value chain, if you take parametric solutions as an example, can be more easily digitised than an indemnity structure. New business models, RYSKEX for example, might boost the industry by disrupting or breaking up the traditional industry. The predicted growth of the parametric market to $30billion by 2031 is not necessarily based on replacing other structures.
“It will likely replace existing structures while also allowing new models to provide insurance protection — where you have a straight-through process from the insured to the capital market.”
RYSKEX’s Schmalbach says the growth in parametrics will be boosted by the digitisation of the captive industry and the introduction of AI.
“ChatGPT has meant there is now lots of attention on how AI works,” he says.
“If we’re talking about the digitalisation of the captive industry, I would say parametric is a wonderful fit.
“With AI, you can make wonderful predictions on potential risks and claim events, as we know, parametric is based on triggers.
He concludes: “The more the captive and insurance industry develops the willingness to digitise and optimise their process to make ‘industry 4.0’ happen, the more parametric solutions will be used. Parametric will grow even further when we start to digitise our industry.”
