The Lahaina fire is a tragedy, a ginormous event in the lives of thousands of people in Hawaii. After all of the fires are out and the emergency responders are on, insurance gets to play its part in restoring their lives and restoring their businesses. Unfortunately, what might be surprising to you is to know that estimates are that almost 50% of the impact of this event are not insured. We want to talk today about what MGAs and carriers are doing with parametric insurance today to try to fill that gap and try to provide more coverage and value for customers.
Economic Damages: What’s Covered and What’s Not
Let’s first start by talking about the economic damages, what’s covered, what’s not, traditional insurance products versus the other elements of insurance that they need. Everybody who knows anything about property insurance will tell you, hey, if their business is burned, if their home is burned, they have coverage for their property will restore it. If they need coverage for extra expense or even if their business is burned and they can’t operate, we can provide them the revenue protection for their lost business as well. Here’s the problem, though: that doesn’t do anything for the folks up the coast in Kapalua, maybe a mile away, who were fortunate enough not to have direct loss from the impact of the wildfire event. But I can guarantee you that fewer people are showing up at hotels, restaurants, and for any and all business activities for everyone who’s running a business just a few miles away from Lahaina. The direct damage that’s done to the properties in Lahaina are covered, but the broader economic impacts of the event are far wider and, in many cases, are not insured. The folks that own a business like an Airbnb or a hotel or anything up the coast, there’s just no coverage for them because they didn’t have an actual direct physical loss to their property.
How Parametric Insurance Bridges the Gap
Parametric insurance is an opportunity that MGAs and carriers are using in a more innovative way today to try to solve that gap, to try to provide coverage where that coverage doesn’t exist. We do this by underwriting the actual event itself and not the actual loss. Parametric insurance products are index based. Any measurable index can be tied to a parametric. We can underwrite the probabilities of that outcome and assign essentially a premium and a limit and make a trade there and essentially assess the risk and provide a product, and the payouts can be predetermined for the actual customer. Take an example: if we wanted to have a triggering event like an earthquake, we would simply say to ourselves, what level of the Richter scale do we want to actually ensure? The underwriters who underwrite these products can say, well, what’s the probability based upon the location of that event occurring, and what kind of limits does the customer need and calculate a premium and ultimately define a predetermined payout that would be available immediately upon that event occurring. Very simple. It’s not a new concept but one that is becoming more viable and more important in the entire insurance industry as more and more extreme weather events are occurring and creating larger and larger gaps of economic damage like the one I shared earlier.
The Role of Technology in Parametric Insurance
You might say to yourself, like, wow, that sounds pretty simple, how come we’re just now getting around to this? The growth of sensor technology, particularly things like satellites and ocean based sensors, land sensors, weather monitoring systems, have created an enormous new understanding of the data of our universe that we can now ultimately measure things and be aware of them and ultimately create the index for things that perhaps were a lot harder 50 or 100 years ago. When you really, on top of that, throw things like cloud computing and AI on top of it, you now have a lot of power to be able to regress and understand that information in very material ways. You start doing is you create a landscape where you can really understand data and precise weather underwriting. This is a map that ultimately depicts over 100,000 individual data points across the United States, and at every one of them, figure a 100 data elements of weather can be understood and modeled and ultimately an index can be built for it to create a parametric solution.
Advantages of Parametric Insurance
What kind of advantages do they have? We talked about a little bit with the wildfire event, but we really can cover new risks and perils. I think the wildfire event that I described is one that we would call non damage business interruption. So, in that case, what we’re doing is saying you didn’t have damage, but you were negatively impacted, and there’s an insurable risk, and we can cover it using a parametric solution. That’s a very new concept, one that mostly larger insurers are buying that kind of contingent business interruption, sometimes referred to as non damage, but it’s not widely available yet in the marketplace. So, it would really be a new kind of concept for the majority of policyholders out there.
We can also look to enhance or modify coverages that we already have. You can change the way the property product works. A lot of people right now in the property space, if you’re at all engaged in that, you’ve probably been delivering a lot of bad news because it’s been harder to get high levels of capacity, and the costs are exorbitant. Parametrics, in some cases, are being used to provide excess layers or for things like catastrophic events like a hurricane. So, in some cases, a policyholder might say, hey, I don’t necessarily need as much limit on my normal property, but as long as I have a $10 million coverage for any Cat 4 or Cat 5 hurricane that comes through, I’m good to go.
One of the other real valuable pieces of a parametric, if you already haven’t figured it out, is once the triggering event happens, we are ready to pay the claim. The adjustment process, the whole concept of did you have a loss, how much was the loss, we need to look at it, we need to look at coverages and look at exclusions, is really irrelevant in the parametric context, which enables us to pay claims much more quickly, much more value to the customer. Instead of spending weeks or months waiting for claims, you’re getting those dollars in real time when they really need them.
Lastly, what we can do is we can actually set and understand risk in very minute ways. Putting a limit on a property building for its replacement cost is the majority of the way property insurance is done, but if I wanted to sort of say I’m only interested in underwriting or taking a certain part of that and putting it on a parametric, you can do that. You can take those probabilities and those different slices of risk, and you can play with them in new ways.
Challenges of Parametric Insurance
Parametrics, like I said, they’re new, it’s maturing, it’s not a you know, it’s part of why we’re up here today talking about it, it’s innovative, right? So, there are some challenges with it. Basis risk: there is the potential in some cases where the claim that is paid under a parametric may not satisfy every aspect of the potential loss that the customer has. It may fill a nice gap, but it may not cover all of it. Insurers are dealing with spread of risk issues because a new product like parametric, if only one customer buys it in one location, let’s say they’re trying to take risk on hurricane risk on the coast, if only one customer is buying a parametric, then it becomes incredibly expensive for that one location because for the carrier, that’s very risky.
Building broader books of business so that the parametric triggers can have a lot more spread of risk is important for the carrier, and that’s one of the challenges as it matures as a product line. Right now, it is fairly much an E&S product. I’m not even aware of any US admitted parametric insurance products yet, and so that tends to limit the access to through E&S chains and brokerage firms. But then the pure awareness and availability of the product itself is very much in its nascent stage of maturation, probably one of the reasons I’m up here talking about it, as many of you might be wondering what it is, never heard of it, and you’re on the front lines, and your clients are on the front lines every day of selling insurance. Agents, in my experience, and professionals in insurance are not going to speak about or deliver products to their customers if they’re not aware of it and understand it, and so there’s a sort of a maturation going on in the US as it relates to parametrics.
Who’s Leading the Charge?
There’s a broad swath of MGAs and specialty brokers that are building unique product solutions that are being used in the parametric space. Parametrics insurance does cloud based insurance; ultimately, if your cloud provider goes down, they will immediately put money in your bank account to help you deal with the restarting with another company. FloodFlash has all sorts of different products for rising flood waters under certain scenarios with sensors; if there’s a claim, if there’s rising flood waters to a certain level, immediate payment. WeatherPromise will actually pay you, as I understand it, to will put money in your pocket if you buy a concert event ticket and it rains and it ruins your experience; you can literally ensure that with a parametric today. Jumpstart, actually, is a company based in California that does a little bit of what I showed earlier with the earthquake. They pay for certain earthquake events and put money right into the homeowner’s account for immediate needs to get out of town, get a new hotel room, not waiting for weeks or months for an insurance company to come look at their damage; it’s immediately put in their account.
Insurers, mostly global insurers, you’d expect their leading edge insurance companies like Liberty, AXA, Allianz, Swiss Re, you can read them, they’re doing a lot of the risk taking support and working with the MGAs as well as large brokerage firms to put unique individual policies together, mostly for large customers. But there’s a tremendous amount of support globally for this kind of risk, and a lot of these, you’ll notice, are foreign based insurance companies. There’s a huge appetite for parametrics in the rest of the world where they have less of a mature insurance, particularly property environment. Parametrics as a solution are efficient and easier to implement, don’t need as many claims adjusters, you don’t need certain aspects, you can pay things remotely. A lot of things can happen in remote and developing nations with parametrics that only in a really mature industry type of model would work with in the US.
A Dairy Farmer’s Story
In case you’re wondering, is this all about catastrophic risk? It’s not. How many of you like to be outside when it’s 95 and maybe 80% humid? Is that a primary, you okay? All right, so you love heat stress, great. Let me tell you about what I’ve learned about cows. Cows don’t like heat stress any more than we do, and when they are under extreme conditions, they don’t produce the same level of milk or the same quality of milk. Many of you who maybe know dairy farmers or cattle owners might understand that.Here’s the deal for a farmer: if it’s really hot out, what happens to your revenue? It goes down. So, there are parametrics being developed where you can buy actual protection against this, which is an index for heat and humidity, temperature humidity index for heat stress. If this farmer works with his agent, buys a product for a $50,000 payout, and the humidity and temperature levels rise above the targeted threshold and the milk production drops, we put a smile on his face with a little money in his pocket to backstop the loss of that weather event.
The Future of Parametric Insurance
At the end of the day, we have a tremendous amount of value that these products are building. They’re very, you can create lots of different risk retention levels, they’re very flexible, we can use sensors and get very personal in terms of where and how we measure things. We really can improve loss costs for insurance companies. As a former underwriting leader, I can tell you I’ve not found any better product to write than a parametric in terms of my confidence level and its ability to develop a long term profitability.We have very simple forms, we can predict outcomes, and very little IBNR.
Once the product is over for the year and there was no loss, you know there’s no loss, you move right along. So, carriers don’t have to carry a lot of challenging dollars on their balance sheet. You’re underwriting a measurable index, you’re not underwriting a person or an operation, so things like the weather are being measured and managed in the index. You don’t have to worry about adverse selection of the policyholder, allows us to provide a lot new types of risk. It definitely enhances the claims experience. At the end of the day, what I want to impress upon everybody here is that the MGAs and the carriers that are involved in this are really trying to create new value for their clients and for the industry. Instead of using data and technology to reduce or to minimize losses or expenses, we’re going to use parametrics to lean in, take new risk, and hopefully build more value for our customers.