Weather and Parametric cover – do you know the facts?

Written by Bill Hardie – Senior Underwriter, Crisis Management & Weather at Liberty Specialty Markets

I’m sure we’ve all heard about parametric products by now, but we’re too afraid to talk about how to really use them. In this article I’ll discuss what parametric products are, and why, when, where, and how we are supposed use them.

The broad application of parametric products in Australia remain in its infancy but these niche products are finding their place amongst an increasingly restrictive traditional insurance market. Parametric products address gaps in traditional cover, exceptions to exclusions, and offer a bespoke cover solution that can be applied to almost any weather situation. A potential client just needs to demonstrate a correlation between a weather event, and the potential degree of financial loss they will incur. Structures can then be tailored to suit client needs.

In 2017, 73 companies on the S&P publicly disclosed a loss of financial earnings that were directly related to weather events.

Weather affects all industries differently. Open conversations need to be held to better understand how weather events can be managed with a parametric solution.

Typical weather perils businesses consider for parametric products include

  • Rainfall (Excess or Deficit)
  • Temperature (Excess or Deficit)
  • Windspeed and direction
  • Flood
  • Earthquake
  • Fire
  • … and any other weather peril that has a reliable data source.

Parametric products look at a known history of data to determine a price, rather than a loss history.

The products then trigger on an agreed set of circumstances that correlate to a payout. Although each product is tailored, the concept doesn’t usually require physical proof of an indemnity loss to establish a basis for a claim. The measured metric either responds to the policy, or it doesn’t.

When designing a parametric product there are two expressions that sum up how best to apply them:

  • “The inevitable is unaffordable.”
  • “Parametric products are designed to complement, not replace traditional insurance products.”

A tailored parametric solution should be designed to protect against the unexpected like any insurance product. However, unlike a traditional insurance product you would be looking to smooth cash flow with a quick settlement – sometimes a delayed traditional settlement is just too late.

The higher the probability an event will occur, the more expensive they become. Also, being ‘non-indemnity based’, data isn’t always perfect, so it’s not a wise risk strategy to put all your eggs in one basket. Remember – A parametric product can run concurrently with a traditional product because a parametric policy insures independent weather data. A traditional product needs to quantify an incurred loss. They remain independent.

Let’s take a look at the following scenario.

Imagine your business is an ice cream stand at the beach. Typically, hot summer weather would drive the sale of ice cream. If the average daily temperature was 25°C or more, then sales begin to respond…. Let’s say you average an income of $100/day.

If the temperature fell below 20°C, fewer people would go to the beach, and naturally, not likely feel the need to buy an ice cream. This may happen on occasion – especially with rainy or overcast conditions. Excessive cold days would really begin to harm your income.

A parametric product could be designed to take the average number of days the temperature fell below 20°C and set this as a trigger – let’s say this is 5 days of cool temperatures. The policy period could be tailored just to cover the summer months (November to the end of February).

After 5 days of sub 20°C temperature are recorded, an amount of $100/ day could be paid for each day under 20°C to offset the business interruption caused by unexpected cool weather (up to the policy limit).

If you follow this, the concept can then be applied to any business / industry, and any weather peril that you can imagine.

In summary, a few take away points when applying parametric products:

  • What: A direct correlation of weather data to a financial loss.
  • Why: Fast payment, self managed claims service.
  • When: Wherever a weather event can be attributed to the cause of a financial loss, and reliable data can be measured.
  • Where: To address shortfalls in traditional insurance coverage, or design a bespoke financial solution that has not been addressed.
  • How: Demonstrate the weather conditions that correlate with your financial loss, and a bespoke structure can be formed to suit your needs.

For more information you can view Liberty’s Weather Index Product Profile here.

Bill Hardie joined Liberty in January 2018 and is based in the Brisbane office. He is a specialist in Weather and Parametric insurance and the companies and industries that can benefit from it. View Bill’s profile here

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