FloodFlash Q&A: Developing parametric and captives

FloodFlash’s head of major accounts and capacity management, Richard Coyle, expresses his views about the role parametric insurance can play in the captive insurance market and how it’s utilisation can be extended in the next few years

 

Captive Review (CR): What role do you think parametric insurance will play in the captive market?

Richard Coyle (RC): Parametric insurance pays out based on the occurrence of a specific pre-determined event or condition rather than the actual financial loss incurred by the policyholder. Simply put, if a measurable event happens, the policy pays out. If this, then that. It is typically used to cover natural disasters such as floods, earthquakes and hurricanes. 2

Parametrics and captives have become very familiar alternative risk-transfer solutions. As the parametric market has grown, combined use with captives has also increased. It’s a hugely exciting time for the industry where technological advancement is already helping captives apply parametric solutions in new and diverse ways.

Parametrics’ principle role with respect to captives is to provide an efficient form of natural catastrophe reinsurance on a facultative basis. Due to the flexibility of parametric policy design with multiple structures possible, it is now straightforward for captives to retain certain portions of the risk, based on their appetite.

CR: How can the use of parametric within captives grow and how will the FloodFlash approach help this?

RC: Parametric usage within captives is not as high as it could be due to the perceived basis risk attached to this different form of cover. This is the possibility that the insured suffers a financial loss, but the coverage does not trigger. Previous parametric flood solutions typically use river or tidal gauges to measure policy triggers.

Gauges can provide accurate, high frequency measurements, however basis risk increases as the distance between the insured property and the gauge increases. It is difficult to correlate a potential loss at your property with a trigger on a gauge which could be miles away.

This leaves a captive with two choices: 1. Pass that basis risk through to the parent company; or 2. Absorb the basis risk within the captive by offering full indemnity coverage to the parent company.

Neither of these choices are particularly appealing. The FloodFlash approach eliminates basis risk as much as possible. We developed a low-cost water-depth sensor which can be attached to the wall of any building or structure. Designed to capture millimetre-accurate water depth measurements at very high frequency during a flood, this small device can be placed in any areas that might be at risk of flooding.

On-site sensor installation drastically reduces basis risk compared to using river or tidal gauges without compromising on accuracy or reliability. As such, the captive is not left with a difficult choice, so we remove that basis risk blocker which I think has stifled parametric uptake by captives to date.

CR: What types of captives and sectors is FloodFlash typically working with?

RC: To date, we have predominantly transacted with single-parent captives, however we’re beginning to see interest from group captives, including those serving the municipality space. From a sector perspective, while our solution is industry and occupancy type agnostic, we tend to over-index in the following: commercial real estate, oil and gas, heavy industry and manufacturing, hospitality and leisure, automotive (open lot), healthcare and public sector. All FloodFlash customers have mission critical properties to protect, and business interruption is often a key motivating factor in purchasing.

Our customers also tend to have higher flood risk and have experienced previous flooding, so finding traditional capacity at affordable premiums is a challenge.

CR: Why should risk managers consider using parametric products in conjunction with their captive?

RC: Risk managers that have implemented a captive strategy are at the top-end of the sophistication scale when it comes to insurance purchasing. Evaluating total cost of risk and striking the right balance between risk retention and risk transfer is the priority, which is more important than ever in the current prolonged hard market.

Having a full suite of risk-transfer solutions available is essential and parametric insurance is now a common constituent of the risk manager’s toolbox. What we see most commonly is the captive being used to retain attritional losses that are too expensive to transfer to the commercial insurance market.

Additionally, attritional losses can be controlled via better risk management practices. Low frequency, high severity natural catastrophe risk is not controllable, so these perils are more fit for transfer. For standalone perils such as flood, parametric is a compelling option as a form of facultative reinsurance.

Carving out the higher risk, higher value locations within a property schedule and addressing these with parametric policies can increase overall programme efficiency. The captive benefits from broader coverage since a parametric payout can be used to cover any and all forms of financial loss resulting from the event.

Additionally, the captive would be paid within days or weeks after the event, meaning that these funds could be passed straight through to the parent company and operating unit in order to aid a quicker recovery.

Finally, the captive also benefits from access to new capacity, which is vital in current hard market conditions.

CR: New legislation in Connecticut will allow captives to accept and transfer risks through parametric contracts. How will this impact the work you are doing?

RC: This was great to see and welcome news following similar legislation passed in Vermont last year. Actually, just a month after the Vermont legislation was passed, we bound our first ever FloodFlash captive reinsurance deal.

The policy was purchased by a Fortune 500 manufacturing client located on the waterfront in Boston. The policy pays $5 million at 16 inches and another $5 million at 20 inches of flood/ surge water as recorded by the FloodFlash sensor, installed on the external wall of the main manufacturing facility. The initial trigger was set to cover denial of access and business interruption, with the secondary trigger covering property damage.

Of course, being parametric, the payout can be used to cover any form of financial loss resulting from the flood event. We hope that the Connecticut legislation will allow us to serve captive clients domiciled there. We are doubling down on our captive focus given our unique position to support their programme management needs.

CR: What do you see as the future of parametrics as they apply to captives?

RC: With continued dislocation in the wider property catastrophe insurance market, particularly in the US, the case for captives to embrace parametric solutions has never been stronger. Captives are being forced to retain higher levels of risk than is within appetite.

The future success of parametrics within captives hinges on how these alternative products address specific pain points. We need to better educate the captive market on how parametric solutions can provide efficient coverage to higher value assets exposed to volatile natural catastrophe risk.

There are many examples of such solutions working really well for captives and increasing awareness of just what is possible will no doubt lead to more uptake. Parametric solutions that minimise basis risk as much as possible will be the most successful, allowing captives to issue back-to-back policy terms to the parent company, preventing gaps in coverage.

12 August 2024
5-6 November 2025

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