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New tech has cut parametric basis risk ‘considerably’: WSIA panel

Daniel vetter and Alex kaplan.jpg
Daniel Vetter (L) and Alex Kaplan (R)

More advanced technology and analytical methods have helped parametric underwriters cut the risk that policies fail to respond as planned, according to senior executives working in the sector.

“The advent of radar technology, satellite imagery, grounding sensor technology, and anything we can derive from the sources has allowed us to minimize basis risk quite considerably,” explained Daniel Vetter, who runs North America underwriting at parametric MGA Descartes.

The executive was speaking on a panel at the Wholesale & Specialty Insurance Association’s (WSIA) annual meeting last week, alongside Alex Kaplan, executive vice president for alternative risk at wholesale broker Amwins.

Designed to eliminate basis risk

Parametric policies differ from traditional indemnity policies in that loss payments are based on certain parameters from the occurrence of a specific event, such as a sustained level of wind speed at a specific longitude rather than the insured incurring a specific loss contained within a policy’s terms and conditions.

Basis risk in a policy with a parametric trigger occurs when an insured suffers a loss, but the threshold of specific metrics from a triggering event is not met, and a claim is not covered. Conversely, basis risk also includes instances when an insured receives a claim payment but has not incurred any loss.

Every time you have a higher deductible, a higher self-insured retention or an exclusion introduced, you're picking up basis risk
Daniel Vetter, Descartes

“I would argue that basis risk exists in an indemnity policy,” Kaplan said, referencing scenarios where payouts to insureds ended up being less than expected as a result of constraints on terms and conditions.

Vetter added that a parametric solution was ultimately designed to eliminate basis risk inherent to traditional indemnity products.

“Every time you have a higher deductible, a higher self-insured retention or an exclusion introduced, you're picking up basis risk,” he said.

“It's interesting that the term ‘basis risk’ only arises in the context of a parametric risk product but never in the traditional insurance context.”

Elevated cat activity driving demand

Executives working in the parametric market have said there has been a major uptick in interest in the product over the last two years, after many insureds incurred significant losses from cat events not covered within their traditional program.

Just last week, fast-growing MGA consolidator K2 Insurance Services said it was launching a parametric business, led by former Swiss Re executive Scott Carpinteri.

And this month, parametric InsurTech Arbol launched a Bermuda-based MGA with reinsurance backing from Sig Re.

Earlier, Bermuda (re)insurer SiriusPoint entered an agreement to provide investment and underwriting support to Parameter Climate, the parametric-focused MGA formed last year by weather risk veteran Martin Malinow.

Like ‘apples to doorknobs’

Proponents of the product argue that the broader coverage has become increasingly essential in a world where risk has grown more complex, and an insured is just as likely to suffer losses caused indirectly by natural catastrophes, such as contingent business interruption, when a local economy is devastated.

Amwins parametric insurance graphic.jpg

Kaplan called parametric protection “very complementary in nature” to traditional indemnity insurance, saying the product “serves a fundamentally different purpose”.

According to the Amwins executive, about 80%-90% of Fortune 500 company balance sheets are made up of intangible assets. He said parametric products were critical to providing protection for what the executive termed as the “indirect effects” of cat events.

“It's not asset protection, it’s balance-sheet protection,” Kaplan said, noting how typical insurance covered physical damage associated with cat evets. “You're looking at the entirety of an organization [and] seeing how a particular risk could metastasize across the balance sheet.”

Vetter said that because parametric covers add value to insureds’ property programs by expanding the scope of losses covered from catastrophic events beyond physical damage, pricing for the product involves modeling the likelihood of a specific event occurring rather than assessing the quality of the underlying risk.

I would also caution apples-to-apples comparison between a parametric cover and the traditional indemnity cover because they are fundamentally different products that create a different value for a client
Daniel Vetter, Descartes

“This is more of a modeling exercise,” Vetter said. “It's actually almost exclusively a modeling exercise rather than underwriting the physical attributes of a specific asset. This is really an exercise of helping a customer and broker to determine what they’re trying to protect, to determine the pain point.”

Along those lines, Vetter said parametric covers are best used in conjunction with traditional programs, to carve out certain locations for specific perils, or as a way of efficiently buying down an insured’s deductible.

“I would also caution against the notion of an apples-to-apples comparison between a parametric cover and the traditional indemnity cover because they are fundamentally different products that create a different value for a client.”

Kaplan added: “I wouldn’t say it’s an apples-to-apples comparison, it’s apples to doorknobs.”

‘Tremendous appetite and capacity’

Both executives said the broad appeal of parametric solutions to capital providers had led to a surge of capacity into the market.

“There is tremendous appetite and capacity,” Kaplan said, noting that the product appealed to insurance-linked securities investors as a diversifying asset class but also owing to the finality of claims for parametrics. “There's no such thing as loss creep or loss development. It's either paying or it's not.

“They're happy to pay a claim, but they don't want trapped collateral sitting, waiting to figure out if they get anything paid out or can deploy that capital elsewhere.”

Vetter added: “There's probably not a shorter-tail product out there. It just simply does not exist.

“This is attractive to any insurer and reinsurer, but it also drives capital into our space. It offers an opportunity to access risk pools you can otherwise perhaps not access.”

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