What is Parametric Coverage?

December 10, 2019

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Is it just me, or do you read the headlines these days and wonder if you are actually reading the plot lines from those “Disaster Movies” that I loved watching when I was a kid?

A major earthquake in Southern California, massive flooding in the farmland, a giant killer storm that takes out Tokyo, or a fast moving wildfire gobbling up acres of prime land by the second—it all seems so fantastical

Except that it is, in fact, real.

As Risk Managers, we have to assume that natural catastrophes (NAT CAT) are going to continue in frequency, grow in severity, and threaten us directly.

The debate rages on as to whether these catastrophic events are caused by climate change. Politics aside, there is no doubt that this is a worthy topic to debate, but our primary task is to protect our property. It is incumbent upon us to first focus on the “if” and “when,” rather than the “why” or “how.”

Consider this, of the top ten most costly windstorms to hit land in the US since 1900:

  • Total Damage is $593B
  • 5 have happened within the last 3 years
  • All but one happened in the 21st Century

How is direct damage covered?

Insurers are fearful of the increasing frequency of these events, and it has already negatively impacted the future prospects of insuring these catastrophic events.

The standard property market remains viable and is still the best solution for direct damage to your project or property. These policies, including any Business Interruption coverage, requires direct damage to your property to trigger the policies.

However, as witnessed by the news coverage of these recent disasters, the areas that are hit can be leveled. Power, water, and other utilities & services that we take for granted can be knocked out of commission for weeks or months.

What happens to you if you are within the disaster zone, but there was no damage to your property? Your property policy will only pay for direct damage to your property.

How do you address the economic impact to your project or property if there is no direct damage? Many insurers are now utilizing a new coverage offering called Parametric Coverage.

This coverage is written to respond to a scenario that is not based on direct damage to your property but will be triggered by a predefined set of Parameters or tied to an index. Wind Speed, Rain Amount, and Earthquake Shake Rates can all be used to define a Parametric Insurance Program.

How are payout tables set up?

Once we define the parameter (ex. wind speed), and a limit of liability (the maximum amount the policy will payout), the underwriter will then provide a payout table. This table defines the percentage of the limit that will be paid if the wind speed reaches the marked parameter. The wind is confirmed by official third-party monitoring stations.

The payout is simple. Continuing this example, the third-party monitoring station confirms that there was a sustained wind speed of 105 mph, with a limit of liability at $10MM. The policy payout schedule shows that at 100 to 110 mph, the insured will get 90% of the limit. A check is sent for $9MM.

There is no proof of loss, there is no question of what was directly damaged, and there is no deductible.

If you are like me, you are probably reading this, tilting your head a bit to the left, squinting your right eye and wondering, “what is the catch?”

The catch is the premium paid and the payout tables are inversely proportionate. The higher the premium, the more spread on the payout table. In our wind speed example with a $10MM limit of liability, two situations are:

Table A

Starts the payouts at 80 mph with a payout of 5% of the limit and goes up to 110 mph for 100% of the limit. The premium is 4% Rate On Line (% of the limit).

  • Premium would be $400K per year
  • Wind event at 80 mph would payout $500K
Table B

Starts the payouts at 60 mph with a payout of 5% of the limit and goes up to 110 mph for 100% of the limit. The premium is 7% rate on line.

  • Premium would be $700K per year
  • Wind event at 80 mph would payout $1MM

The question then becomes, is it worth it to pay these premiums?

The answer: It depends.

Parametric coverage is not a substitute for standard property insurance and can be very costly. However, if done correctly, it provides your company with protection against the cataclysmic aftermath of these amped up NAT CAT events.

If you want to learn more information about Parametric coverage or if you have questions about any of your policy coverages, contact TSIB today!

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Topics: Construction Commercial Insurance

Written by The TSIB Team