Parametric insurance can play a significant role in closing the insurance protection gap – a problem that plagues economies in both the developing and developed world, according to a report published by Clyde & Co.

The protection gap is the amount of economic loss that isn’t insured; it is a measure of the difference between insured and uninsured losses, said the report.

The problem is that individuals, businesses, communities and nations are less resilient – or less able to bounce back and recover after natural catastrophes – when they are not covered by property insurance, said the Clyde & Co. report titled “Building a resilient world: How parametric insurance can help close the protection gap.”

Indeed, a one percent increase in insurance penetration would lead to a reduction in the disaster burden on taxpayers of 22 percent and help communities get back on their feet more quickly and efficiently, said Clyde & Co., citing a Lloyd’s report on underinsurance, published in 2012.

What is parametric insurance and how can it help close the protection gap? Parametric insurance pays a fixed amount when a triggering event occurs such as a certain wind speed in a hurricane or an earthquake of a particular magnitude.

It provides “rapid funding for relief, recovery and reconstruction efforts, and so may have the greatest potential impact in countries most dramatically affected by natural perils and where the protection gap is currently large,” said the report.

Parametric payments do not require on-the-ground loss adjusting, so payments can be made quickly in hard-to-reach, remote locations, “often via online payment platforms or through mobile phone networks,” said the report. “Parametrics are also extremely useful where there are wide-ranging and hard to quantify losses, for example at the national scale,” it added.

“[O]ne parametric crop policy is triggered on satellite images of grazing land – where a lack of greenery or yellow land indicates the crop is failing,” the Clyde & Co. report said. “If funds can be made available promptly to a vulnerable region, resources can flow to feed both people and livestock before famine strikes and migration follows.”

The report said that Caribbean nations hit by Hurricane Ivan in 2004 were some of the earliest proponents of parametric insurance. These nations came together to create a regional risk pool against severe weather, now known as the CCRIF SPC (formerly the Caribbean Catastrophe Risk Insurance Facility).

[Editor’s note: CCRIF limits the financial impact of catastrophic hurricanes, earthquakes and excess rainfall events to Caribbean and Central American governments by quickly providing short-term liquidity when a parametric insurance policy is triggered.]

Overcoming Entry Barriers

In addition to helping build resilience to natural disasters and weather events, parametric products can also “help overcome some of the barriers commercial insurers can face when entering new and developing markets,” it went on to say.

“For example, governments in developing markets may have concerns about international insurers competing with local insurers for standard business. These barriers tend to be less problematic when international players can demonstrate they are offering something unavailable in local markets.”

Effects Growing in Developing Nations

The report discussed the fact that the protection gap is a problem across the globe, in developing as well as developed nations, with only about 30 percent of natural catastrophe losses covered by insurance in the past 10 years.

The problem is particularly acute in middle or low-income countries where the uninsured proportion of economic losses often exceeds 90 percent and the worst natural catastrophes can “permanently reduce a country’s GDP by almost 2 percent,” the report continued.

And the situation is likely to get worse given the increasing frequency and severity of natural catastrophes brought about by climate change, it said. “The International Monetary Fund (IMF) has concluded that countries located in the tropics, the vast majority of which have a low GDP, will bear the brunt of more regular weather-related shocks.”

“In fact, the number of weather-related loss-events has tripled since the 1980s and inflation-adjusted insurance losses in the same period have increased from an annual average of US$10 billion to US$50 billion,” said the Clyde & Co. report, quoting statistics from Munich Re.

Developed World’s Protection Gap

Although the protection gap is widest in the developing world, its financial impact is more substantial in developed economies.

In absolute terms, the U.S. Japan and China “account for the biggest share of the global property protection gap, with expected annual uninsured losses of more than US$81 billion, which is more than two-thirds of the total gap of US$120 billion for the same countries,” said Clyde & Co., quoting a Swiss Re sigma report on underinsurance of property risks, which was published in 2015.

Huge Potential

The Clyde & Co. report was optimistic about the huge potential of parametric insurance, which is increasingly accepted by the industry, governments and end users.

“With support and increased understanding, parametric insurance can fulfill its wide-ranging potential and, alongside traditional insurance and other novel forms of risk transfer, play a key part in closing the protection gap and strengthening global resilience,” the report went on to say.

Nigel Brook, partner, Clyde & Co, commented: “Parametric insurance products are developing rapidly at local, regional and national level as they provide an elegant solution for risk-transfer concerns, often for populations that were previously uninsured and for whom the protection gap has traditionally been widest. That is why they are gaining so much attention, particularly following a year where the threat from natural disasters has been writ so large.”

*This story ran previously in our sister publication Insurance Journal.