TRIGGERED: should captives be utilising parametrics?

Over the past few years parametric solutions and their uses have started to get more attention.

But what is a parametric solution?

Parametric insurance, a non-traditional insurance product which delivers pre-specified pay outs based upon a specified trigger event or limit, is a known concept. While parametric insurance is not a new concept throughout the insurance ecosystem, it is, however, a concept which is currently not being widely utilised by captives.

Seattle-based investment adviser Parametric, a leading organisation within the advisory space who hold over $410bn in assets under management (AuM), describes their approach to client service as “providing systematic solutions fuelled by investment science”.

The investment industry knows all about parametrics. The assessment through quantitative forecasting and other complex scientific methodologies to gauge the inherent risk in investing in certain high-volatility products, has also been a known tool throughout the broader financial ecosystem since the 1990s. While not common, some hedge funds also make use of parametrics when optimising their portfolios.

The question is this: does a parametric approach, resulting in a pay out when risk levels are broached and exceeded, make sense for captives?

An inflection point for captives’ adoption of parametrics?

At this year’s Vermont Captive Insurance Association’s (VCIA) annual conference Arbol, an Insurtech platform for adverse weather protection products, unveiled an innovative parametric solution for captives.

Understood to be the first captive-centred platform of its kind, Arbol’s ‘Parametric+Captive’ solution is set to help enable organisations to take immediate action towards climate change risk management by transferring climate risks into captives using a parametric structure.

Overall, the platform will allow corporations to take a first step towards formally managing climate risks, understanding the impact of climate risks, and getting prepared for external risk transfer.

Arbol’s platform leverages AI, machine learning and blockchain technology enabling individuals to customise parametric coverage programmes for a variety of weather risks across several industries within minutes.

Hong Guo, Arbol’s executive vice president and CIO, opined that the solution would “first manage risks in their [clients] captives using a parametric structure, develop a better understanding of the climate change risks and their impacts, and finally achieve the optimal risk transfer/retention balance.”

Explaining further the ethos behind launching the solution, Guo told Captive Review “the Captive+Parametric solution was created to enable corporations to take concrete action towards managing climate change risks by using a captive as a risk management mechanism and using parametrics as a product structure.”

As the first platform solution of its kind, it seems likely that further companies may follow suit and create their own solutions in this space. For now though, Arbol’s solution, at the very least, should enable early adopters to begin managing climate risks via a captive.

It also does so straightforwardly on a centralised platform – utilising the Insurtech’s solution to compute the correct cleaned, standardised, and usable climate data which would be a tall order to obtain efficiently in isolation.

Time will tell how successful the take-up of such a solution will prove to be for the captive insurance industry, and Captive Review will be keeping a close watch on any future developments.

Do parametrics make sense for captives?

The pay out of a parametric policy depends on the reported parameter or index and the pay-out amount is pre-agreed; therefore the funds can be released very quickly. It’s a key reason why parametrics have traditionally proven to be an especially popular mechanism throughout the public sector when it comes to first aid and immediate relief.

Martin Hotz, head of parametric nat cat at Swiss Re Corporate Solutions, highlighted the further advantage of parametrics being transparent at the outset with proceeds able to be used with no fine print or exclusions.

“For certain types of asset or for companies that have a business model heavy on intangible assets and where the intangible assets are difficult to capture through traditional policies, parametric insurance plays an important role,” Hotz said.

Therefore, adding a parametric policy into a captive may really depend on the specific lines of risk being covered by the captive. For the right entity, the adoption of a platform solution like Arbol’s and others which may come to market in future could make perfect sense. Further, the value in utilising parametric triggers may depend on the overall coverage intentions of the captive and whether a given owner or manager can accept the potentially undesirable effects of using parametrics in a captive.

“When it comes to the captive purchasing protection, having reinsurance with a parametric element would speed up claims payments and allow the captive to deliver to the policyholder/parent quickly which is of benefit,” Adele Gale, head of ILS at Robus, said.

Gale is optimistic that for the right individuals successful uses of parametrics in captives will be found, but she also pointed out the fact that using parametrics in a captive would introduce basis risk.

“The basis risk may be undesirable and need to be passed on to the policyholder/parent to ensure a coverage gap doesn’t emerge,” she noted.

Depending on the organisation and their overall risk appetite, parametrics may prove a highly worthwhile solution for captives, but this may not be the case for everyone.

“For a captive, there is a far greater degree of trust between the captive and the policyholder/parent meaning that claims can be settled quickly and efficiently as standard and the basis risk introduced by a parametric trigger is likely to be undesirable,” Gale said.

For certain captives this introduction of basis risk may indeed serve as a deterrent. However, Dr Marcus Schmalbach, CEO at RYSKEX, is optimistic.

“Every single contract has the potential of a basis risk whether it is indemnity or parametric,” Schmalbach said. “With parametrics, you can choose trigger combinations, and I would always advise people to not only focus on a single trigger—for example a wind storm being faster than 7.5 knots—but to fight the basis risk by involving a second trigger, too, in order to clarify that the claim has really occurred for the company.”

The essential function of a captive is to cede money to their parent when the parent experiences a loss event. “I would say the issue of basis risk is not one that exists between the captive and its parent company,” Schmalbach said.

“This trouble comes in because captives tend to have a reinsurance contract with the traditional insurance market; and they are typically the ones who are not comfortable with the matter of basis risk. In the case of parametrics, it is more likely to be a concern of external risk takers that the level of a forecasted pay-out for a loss event be set too high.”

The value of parametrics for captives

Volatility wrought by the hardening market may be the prompt for organisations with captives to look at getting parametric coverage. The unexpected virility and staying power of the coronavirus pandemic has prompted organisations at all levels of the financial services industry, not least those involved in the insurance space, to try and find new solutions for clients’ problems.

This push from the hard market, as well as the continuing increase in catastrophic natural disasters, provides further impetus for captive owners to look at how they might realise capacity or account for business interruption risks that were perhaps not even being considered before the pandemic began.

Explaining some of the key advantages to utilising parametric coverage in a captive, Cole Mayer, senior vice president at Swiss Re Corporate Solutions, pointed out parametrics’ ability to help “smooth over” volatility, an ineluctable fact of the marketplace that captives tend not to do especially well with.

“Parametric covers can help smoothen out volatility in a market context where it can be tougher for captives to secure, for instance, adequate limits in the natural catastrophe space,” Mayer said.

“In the hard market context captives are being asked to take on more risk, and possibly beyond the comfort levels of the parent or captive around that retention, particularly regarding volatile perils such as floods, earthquakes, and hurricanes.”

The final noteworthy piece about parametrics is that they are a usefully adaptable solution. “Parametric covers are very bespoke in terms of how they’re designed and can therefore solve problems that traditional insurance struggles with,” Mayer told Captive Review.

Looking ahead

One of the ultimate boons of parametric covers may reside in the bespoke nature of these plans and the fact they can help secure at an equivalent level the inherent risks for organisations with operations throughout the world. While Arbol’s solution may get captives thinking about parametrics, more education is seemingly needed – and it’s only fair to wonder why this is the case.

As mentioned earlier, parametrics are not a new concept, but they are one largely underutilised and with their value curiously unrealised by captives. And as Schmalbach pointed out with parametrics, the claims adjustment process is very straightforward. So, why are parametrics not more well-known about in the captive space? The answer is not a simple one, but as more parametric solutions for captives come to market, perhaps their utilisation will begin to increase.

12 August 2024
5-6 November 2025

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