By Dr. Rom Aviv
Senior ILS Adviser, Twelve Capital
"Parametric insurance offers an attractive opportunity to diversify portfolios, access attractive uncorrelated returns, and align with the growing focus on climate resilience and technological innovation"
EXECUTIVE SUMMARY
Parametric insurance is emerging as a transformative risk transfer solution, addressing coverage gaps and inefficiencies inherent in traditional indemnity-based insurance.
For investors, this niche within the insurance-linked securities (ILS) market offers an attractive opportunity to diversify portfolios, access attractive uncorrelated returns, and align with the growing focus on climate resilience and technological innovation.
This resource, developed by Twelve Capital, a leading investment manager specialising in insurance-linked securities, delves into the mechanisms, applications and benefits of parametric insurance from an investor’s perspective.
This paper demonstrates how parametric insurance can enhance resilience and unlock unique investment opportunities through structured, data-driven instruments.
INTRODUCTION
The global insurance market presents significant opportunities for growth and innovation, driven by the increasing focus on addressing climate-related events and enhancing efficiencies in claims management.
Parametric insurance, which triggers payouts based on predefined parameters (e.g., weather thresholds, earthquake magnitudes), offers a streamlined and transparent alternative to indemnity-based insurance.
From an investor's perspective, parametric structures offer a compelling combination of objective, data-driven risk assessment, technological scalability, minimised uncertainty in claims management and losses, reduced trapped capital risks, attractive return potential, diversification benefits, and opportunities for social impact.
These attributes position parametric solutions as a valuable and innovative addition to modern investment strategies.
THE EVOLVING INSURANCE MARKET
Over the past 25 years, the ILS market has largely been dominated by indemnity-based transactions. The dominance of the indemnity business can be traced back to the original purpose of the ILS market: to replace scarce risk capacity and provide much-needed protection to hedgers, primarily insurers, seeking capital. Indemnity transactions, while essential, require expertise to assess the impact of hazards on insured assets, creating information asymmetries between the insurer and the insured.
In contrast, parametric insurance provides a level playing field with symmetric information between the risk-bearer and the protection buyer, making it easier to understand and manage. Despite these advantages, parametric insurance has remained a niche within the ILS segment, with much of its activity limited to catastrophe bonds led by development banks or small private transactions. However, shifting market dynamics, technological advancements, and a growing recognition of its benefits are transforming this landscape. With increased scalability and more ILS-compatible structures, parametric insurance is now positioned to offer accessible and attractive investment opportunities for capital providers.
HURRICANE ANDREW 1992
HOW PARAMETRIC INSURANCE WORKS
Parametric insurance is a data-driven and efficient form of risk transfer that streamlines the claims process by providing rapid payouts based on predefined, objective, and verifiable triggers. Unlike traditional indemnity-based insurance, which reimburses actual losses, parametric insurance pays a fixed amount when specific conditions are met, such as the occurrence of a natural catastrophe. For instance, a parametric hurricane policy might trigger a payout if wind speeds at a specified location exceed a predetermined threshold.
Key components of a parametric insurance structure include:
Covered Area: A clearly defined geographic scope, often represented by a set of specific polygons or circles.
Covered Event: A specified natural hazard, such as a hurricane or earthquake, that triggers the policy.
Payout Structure: A prearranged mechanism detailing the level of loss to investors, often tiered based on the severity of the event (e.g., 50% payout for a Category 3 hurricane, 75% for Category 4, and 100% for Category 5).
Transaction Tenor: The duration of the risk period covered by the transaction.
Covered Amount: The total size of the transaction, defining the potential exposure.
As an investment, parametric insurance offers a simpler and more transparent structure compared to traditional indemnity insurance. Claims depend solely on external, objective triggers rather than complex assessment processes, making it an attractive option for investors seeking clarity and efficiency in risk transfer.
The differences in the fundamental structure of parametric insurance and indemnity insurance lead to significant distinctions in two critical areas: claim management and speed of claim payment.
Claim Management and Loss Adjustments: Parametric insurance simplifies claim management by removing the need for loss adjustments, as payouts are based solely on predefined, objective triggers such as weather data or seismic activity. This eliminates on-site inspections and damage assessments. In contrast, indemnity insurance involves a detailed and often complex process, requiring documentation, loss adjustments, and negotiations to verify actual damages, which can lead to potential delays and disputes.
Speed of Payments: Parametric insurance offers rapid payouts, typically within days or even hours after the triggering event, as it bypasses the need for loss verification. This provides immediate liquidity for policyholders to address recovery needs. Indemnity insurance, however, is much slower, with payments often taking weeks, months, or even years due to the extensive claims process, which includes assessments, documentation reviews, and possible disputes before finalising the payout.
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The information given herein was prepared on 31 January 2025, unless otherwise specified.
FUND OBJECTIVES AND RISK CONSIDERATIONS
The objective of the Fund is to achieve long-term risk-adjusted returns for Investors by creating a diversified portfolio of investments with a focus on insurance risks including natural catastrophe and weather-related risks. The fund is subject to the following risks: exposure to non-parametric insurance risk, event risk, model risk, counterparty risk, valuation risk and liquidity risk.
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