‘Only a matter of time’ until parametrics become the norm

Texas-based energy, commodities and services company Enron was notorious for its fraudulent activities and descent into America’s largest corporate bankruptcy in 2001 – however, the firm was less known for its role as a trailblazer in parametric trading.

Seizing upon advances in computer technology and the availability of more reliable data, it invented weather payment derivatives in 1997.

For every degree dropped in temperature, American firms could get $10,000 (£8,150) compensation to mitigate weather-related losses.

Enron’s innovation 25 years ago has paved the way for today’s parametric insurance offerings, which is on the cusp of a new boom.

Parametric expansion

Weather-related payments in energy and agriculture insurance classes are now well established.

Other lines of parametric insurance are evolving fast, with firms offering products across lines such as cargo and transport, cyber downtime, non-business interruption and travel insurance – for example, with payouts for delayed or cancelled holiday flights.

Insurance professionals are wondering whether the industry is on the cusp of a new boom in parametric insurance.

These policies work by paying out to policyholders when a trigger is hit based on pre-defined data parameters - for example, a specified amount of water flooding into a property.

The fast and transparent claims payment process is appealing to end customers.

“If [parametric insurance] becomes more widely adopted, there’s no reason why it can’t be as big as the cyber or the directors’ and officers’ market,” said Paul Ramiz, director of broker Aon’s innovation and solutions team.

“Essentially, what we see happening is that more traditional risk managers will buy parametric layers within their programmes.

“That, over time, would then escalate the maturity and grow the market.”

Charlie Langdale, head of climate risk and resilience at Howden Group, added that even within the weather-related sector, the potential for parametric policy growth is large.

“Climate change is causing a lot of weather volatility. So, people’s idea of what is normal weather is changing very fast and, therefore, trying to offset that exposure with a really simple insurance policy which effectively triggers an index is much more appealing now than it was even three years ago,” he said.

Sector potential

Parametric insurance growth prospects in weather-related insurance looks promising, but what about other areas of insurance?

Oxbow Partners’ head of market intelligence, Paul De’Ath, said: “[Parametric insurance] can only exist with certain parameters in place.

“So, as an example, I would expect that it’s very difficult to use any kind of parametric triggers on a car accident because you don’t know exactly what’s going to happen until it actually happens and it’s not something that is easily measurable beforehand.

“Whereas something like crop insurance, where the crop is heavily dependent on the weather, you can objectively measure whether or not there has been sufficient rainfall to grow the level of crops that you’re looking to grow.

“Those two things work in tandem – [that is where] you can get to a position where parametric insurance works very well.”

Ramiz, meanwhile, noted that one of the big challenges for new lines of parametric insurance is that they are at an early stage of adoption.

He explained that it is “very difficult to get buyers to buy into new things”, such as parametric travel or non-damage business interruption policies, because “budgets [are] set early”.

“That’s the problem,” he said. “The impediment [to] growth is probably its innovative nature.”

Despite this roadblock, Ramiz believes it is “only a matter of time” before parametric insurance “becomes part of a traditional policy because of the benefits that claims are paid so quickly”.

He continued: “It’s also very transparent and you remove some of that litigation.”

The insurtech: Parametrix

One of the innovators in the parametric insurance arena is Parametrix.

The insurtech offers insurance for companies that rely on third-party cloud providers, e-commerce services and payment gateways.

Parametrix’s pricing model uses millions of data points to help customers understand their downtime risk.

For claims, the customer puts forward a payment rate per hour of downtime, which is when a computer or IT system is unavailable, offline or not operational. The premium is commensurate with the payout.

Parametrix is an alumnus from Lloyd’s Lab, the innovation startup hub for insurtechs.

In 2020, Parametrix was one of 12 startups selected from a beauty parade of 90 insurtechs, keen to take part in the Lloyd’s Lab accelerator programme.

A year later, the insurtech had secured a $17.5m (£14.3m) funding round.

One of the co-founders and the firm’s chief executive, Yonatan Hatzor, told Insurance Times that the insurance industry is only just starting when it comes to this type of parametric downtime insurance payment model.

Hatzor estimated that the cloud technology industry is valued at around $600bn (£489bn), meaning that “the market is definitely huge” and an opportunity to be seized by insurance innovators.

“Think about the losses that businesses experience every year, [of around] $700bn (£570bn),” he said.

“Not all of this wants to be insured, but the correlation is that you have around $60bn (£49bn) potential premium for this market segment.”

What gives parametric insurance its potential for growth is the “amazing” client experience, Hatzor added.

He explained: “The market right now is inefficient in the worst way. And when you utilise [a] parametric model, you make things really simple for the client.

“They know exactly how much they want to get in the case of downtime. They can then plan ahead when they want to mitigate a disaster scenario.

“And on the carrier side, you don’t spend so much money on claims processes, investigations, forensic teams. Everything is efficient.

“You know exactly what your exposure is. You know how to manage your capital. In the case of downtime, you can [be paid] immediately and that’s great because it saves you so much money.”

Langdale described Parametrix as “real pioneers” of parametric insurance. He believes downtime cover has great potential for businesses of all shapes and sizes.

He said: “What’s clever about [parametric downtime insurance policies] is that they are much more useful for smaller [and mid-sized businesses] that want a simple product against really catastrophic events. The sort of events where they say: ‘Oh no, I can’t access my servers for the next week’ and there’s a huge amount of revenue at stake.”

Langdale predicted that parametric policies “will grow a lot”, with downtime covers ringfenced as “the next stage of growth in parametric insurance”.

“It’s just a matter of people inventing new ways to put indexes out there,” he added.