Parametric insurance: better for business interruption?

By Ken MacDonald for Skyline Partners

Insurance is an essential purchase to protect assets, earnings, and cash flows, but it doesn’t always do well with risks that don’t fit the typical indemnity-based coverage model. Business interruption (BI) insurance, for example, is one of the most common lines of coverage. When purchased, it is almost always bought alongside physical damage insurance, and despite its relatively high cost, it is subject to excruciatingly complex coverage conditions and calculation methodologies. In practice, that means it won’t always respond when the insured’s business is interrupted.

The coverage trigger is typically a physical loss. An insured organisation may suffer a financial loss of multiple millions due to an interruption of its business, but without $1 worth of physical damage, that loss is generally uninsured. Some insurers offer so-called Contingent BI, but the market is neither wide nor deep. This does not seem sensible in our globally interconnected world, with its fiendishly complex international supply chains.

A cursory examination of almost any organisation will reveal myriad ‘non-damage BI’ risk scenarios which are entirely uninsured, or at best only partially covered. Consider these scenarios:

  • A natural catastrophe event on the other side of the world shuts down the port that temporarily hosts your critical manufacturing components. The widgets are covered, but not the expenses and losses you incur because you don’t have access to them.
  • You’re a retailer with substantial high value stocks at a third-party warehouse that is shut down, preventing access to your product (perhaps due to a strike or civil commotion, a nearby environmental incident, a wildfire, etc). Your stock is not damaged, but your business certainly has been, without insurance coverage for your financial loss.

These uninsured costs may include lost customers, fulfilment delays, additional costs to secure additional supplies, broken service-level agreements, reputational damage, excessive management time… the list goes on.

Parametric can assist. Parametric insurance products avoid entirely the complexities of policy wordings, indemnity calculations and loss adjustment, and the other pain-points of insurance claims. Trigger the agreed index governing the parametric coverage, and the money gets paid. It’s that simple.

Parametric is analogous to Industry Loss Warranties, or ILWs, a tool reinsurance markets have used for decades. ILWs focus on catastrophe exposures like earthquake and flood, and cover gaps in the traditional outwards programmes bought by re/insurers, or cover their retentions. For example, an insurer exposed to US NatCat perils might buy an ILW with a $20 million limit that’s triggered when total industry losses for the insured perils – as assessed by a trusted third party (the index provider or “computation agent”) – exceed, say, $10 billion.

Such products can be structured in many ways, including with a parallel indemnity trigger, but my point is not to discuss ILW’s. Rather, I wish to highlight the similarities between these highly complex products, which are widely purchased by institutional buyers, with parametric structures that are now emerging as the same type of solution for corporates and other large insurance buyers. Complex reinsurance structures and processes have often filtered down to insurance buyers. The list includes captives, actuarial analysis, direct reinsurance buying, assuming significant retentions, incubation of non-traditional risks, and now parametrics.

We now have advanced abilities and available analytics to structure sound indices to act as a proxy for many perils an organisation faces. Weather data such as temperature, wind speed, and rainfall has been available for decades, but now we have satellite imagery, transponders on vessels, tethered floating buoys, telematics, and multiple other high-tech data collection technologies – as well as the computing power to analyse it all. Our scope to define a peril using an index has never been greater.

An early Lloyd’s Lab graduate, Skyline Partners is leading the way to place parametric solutions within reach of insurance buyers. They can help you to structure and operate parametric insurance protection against almost anything that can be observed and measured, including risks which do not lead to physical damage to property. Parametric is a new kind of insurance for a changing world, and Skyline makes it happen.

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