Not just a reinsurance tool: Demystifying parametric products and their growth in the US retail market

Chaucer partner K2 Parametric was able to anticipate this growth and now head into their third year of providing natural catastrophe parametric products to corporate clients.

We spoke to President Scott Carpinteri about what makes parametric products so appealing for consumers and where they see the growth in future.

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The principle of indemnity in traditional property insurance is relatively straightforward: Data on physical assets is easily quantifiable and therefore subject to relatively simple underwriting rules. What becomes extraordinarily difficult is quantifying the ancillary costs that come with almost any property-related loss scenario - extra expense, non-damage business interruption, contingent business interruption etc.

Because we cannot predict the future easily in terms of time taken to restore business as usual, these grey areas can be extremely hard to measure, hard to underwrite and hard to adjudicate, so losses can become very messy. The profile of this became elevated by the Covid-19 pandemic. Even though those were unprecedented circumstances, people became extremely aware of how policy wordings and exclusions work, and the principle remains that obtaining funds quickly is critical to restoring operations following an unexpected loss.

Parametric products can take the messy and make it clean.

For all of those costs which it's hard to do a good job underwriting, for claims where there are sub limits, exclusions or a lengthy adjudication process; all of these areas of friction and protection gaps may be eliminated by a parametric product. People are appreciative of the speed and clarity of parametric products.

When we underwrite a parametric policy, we pivot the underwriting process to focus on the event itself rather than the insured and their risk; the probability of certain wind speeds happening, in that location. If the wind speed occurs at the agreed location, the policy pays out and the money can be used for whatever the client needs it for, it really is usually this straightforward. This allows for recoveries that the client can use for all those things that traditional underwriters just can't cover, which is why the product is becoming popular - and why it's valuable.

For example, you might have a resort in a wind-prone area such as South Florida, with several million dollars’ worth of landscaping, beachfront pools and cabanas etc. Very little of that exterior can be insured on a traditional indemnity basis as it's all very fragile. Many underwriters stay away from that by either selective underwriting or exclusions – or more commonly with a big deductible. A parametric product can be purchased for quite small limits, and it doesn’t specify what you can and cannot use the money for. Plus, it usually pays within a matter of a couple of weeks.

When things go wrong, a traditional indemnity policy asks the insured to tally up what went wrong in order to make a claim. This process can be length and is always subject to what insurers will cover according to the supplements and exclusions in the policy, which exist to ensure that they will only pay for what they are comfortable with.

The parametric policy flips this 90°. It acknowledges that the policy will not make the client whole in the way a traditional insurance policy does. There is an extraordinarily high probability that insureds will have costs for strange, unexpected things that went wrong during a loss event. At minimum their deductible is exposed which, nowadays, may be higher than they would ideally be comfortable with.

Our method is that we recommend clients buy an amount of parametric cover that they can afford and think is a good value proposition, and when that event occurs, they receive those parametric funds directly, within a matter of weeks, which will take some of the pain out of the event and funds those ongoing unexpected costs. It’s great for helping cash flow considerations – so what we're selling is not making whole, it is pain reduction.

Education is very important in this process. The client pays the broker to be their advocate, to question things and make sure that what they're seeing is legitimate. With relatively new products like this that role is more important than ever because brokers can help insureds understand how these products can really help take the pain of natural catastrophe losses away.

It’s also important for brokers to keep educating their clients over time because take-up of parametric products tends to be slow, as people learn how it works and why they need it. Traditional insurance has been around forever and is bought year in year out. With parametric insurance, we might have a conversation one year, and perhaps the next, and by the third year, insureds are ready to buy.

The interesting part with what we do is it does not appeal to a single geography, a single class of business or a single size of buyer. We have policies all across the United States including Alaska and Hawaii, with different parametric triggers.

Many people think this insurance could be a little bit sophisticated for them, but that’s not at all the case. It’s not just Fortune 100 businesses that buy this cover – I’ve sold parametric to the biggest companies in the world, but also to a single hotel owner of a modest size hotel. We are there for those clients that care about their insurance, who read their policies and ask their brokers questions, they have perhaps lived some tough claims.

Anybody who has bought their deductible down because they are risk-minded but could not manage operationally if they were forced into a 10-15% deductible. Public entities are a key buyer for us because liquidity is so important to them. Anyone who doesn’t have significant reserves available to fund them for a long period of adjustment in the case of a complex loss.

By corporate insurance standards, this is a relatively new area. It requires people to look at insurance in a very different way than they have traditionally, and I am constantly working with brokers, buyers and carrier partners to make sure people understand what this is and what it isn't.

So, for me, it's really important to work with people who want to learn something different, to do something a different way. Working with Chaucer as a partner, since the first call we had years ago, it has been very clear that the team were digging in to try to understand what this is, how it works and how it's actually very useful as a tool to many kinds of client. This is a solution that's a win-win for both the insured and the insurer, I 100% believe that, and am delighted to have Chaucer’s support.