Parametric insurance: Using objective measures to address the impacts of natural disasters and climate change

Environmental Claims Journal

Volumn 23, Issue 3-4, 2011, Pages 227-237

  van Nostrand, James M ^a   Nevius, John G ^a  

^a PACE UNIVERSITY   (United States)

Author keywords

[No Author keywords available]

Indexed keywords

CATASTROPHIC EVENT; CLIMATE CHANGE; DEVELOPING WORLD; HAZARD MANAGEMENT; INSURANCE SYSTEM; INTERNATIONAL COOPERATION; MITIGATION; NATURAL DISASTER;

EID: 80052844391     PISSN: 10406026     EISSN: 1547657X     Source Type: Journal    
DOI: 10.1080/10406026.2011.607066     Document Type: Article

References (72)

1. Saundra Bailey, Insurance as a Risk Reduction Tool: Role of Parametric and Traditional Insurance (Caribbean Emergency Legislation Project, March 2010), 2. http://www.oas.org/dsd/Energy/Meeting/Documentos/SaundraBaileyspresentation.pdf (hereinafter Bailey presentation).
2. Swiss Re, Weathering Climate Change: Insurance Solutions For More Resilient Communities (2010), 3 (hereinafter Swiss Re report).
3. "Intergovernmental Panel on Climate Change, Fourth Assessment Report," Climate Change 2007: Synthesis Report, 45.
4. Report of the Economics of Climate Adaptation (ECA) Working Group, 2009, "Shaping Climate-Resilient Development-a Framework for Decision-making," 16.
5. See note 1, supra.
6. Hector Ibarra, Parametric Insurance: GeneralMarket Trends and Perspectives for the African Insurance Sector, http://www.africa-re.com/WEATHERINSURANCE.pdf, 1.
7. Evan Mills, From Risk to Opportunity: Insurer Responses to Climate Change, 1, CERES, April 2009.
8. Swiss Re report, supra note 2, 5.
9. Ibarra, supra note 7, 1.
10. Bailey presentation, supra note 1, 12.
11. Simon R. Young, Risk Transfer Via Parametric Insurance: The CCRIF Experience, 3. http://cdm.cdera.org/cccdm/2007/cd/Data/SYoungCDERACDMCCRIFcasestudy.pdf (hereinafter Young Risk Transfer presentation).
12. Parametric policies pay out on the basis of the expected loss determined through a measured parameter of the hazard event. For hurricanes, the parameter is wind speed. For earthquakes, it is ground acceleration.
13. Id., 11.
14. Using published information to characterize an event (by the U.S. National Hurricane Center for hurricanes and by the U.S. Geological Survey for earthquakes), an equation is used to determine the parametric index value (equating to loss) for each country for the event. For larger countries, the total index value is a weighted average from two or more measurement points.
15. Cat modeling uses scientific methods to recreate a loss database for rare events such that actuarial analysis can be undertaken.
16. Simon R. Young, Risk Modelling & Parametric Insurance, December 2008, 3. http://cdm.cdera.org/cccdm/2008/cd/data/monday/ccrif/ccrif.pdf (hereinafter Young Modeling presentation).
17. Cat models comprise three elements: (1) a natural-science-based hazard module, (2) an engineering/empirical damage model, and (3) an actuarial/financial model.
18. Young Risk Transfer presentation, supra note 14, 3.
19. Bailey presentation, supra note 1, 18.
20. The parametric inputs of ground-shaking and wind speed are directly from government agencies whose information is dispersed widely in the public domain. This transparency assists in the pricing of CCRIF policies and eliminates coverage-based litigation over the policy.
21. Daniel E. Peterson, Financial Adaptation through Parametric Insurance Products: Utilizing the Caribbean Catastrophe Risk Insurance Facility as a Model for a Proposed United States National Catastrophe Risk Consortium (University of North Carolina School of Law, Center for Law, Environment, Adaptation and Resources), 24. http://www.law.unc.edu/documents/clear/danielth.pdf (hereinafter Peterson study).
22. Id., 17-18.
23. Id., 18.
24. In the case of traditional insurance, large sums of money have to be set aside by insurers and reinsurers to pay for potential large losses, which increases the cost of capital.
25. Bailey presentation, supra note 1, 18.
26. Young Risk Transfer presentation, supra note 14, 19.
27. Simon R. Young, Alternative Risk Transfer, and CCRIF as an Enabling Vehicle for Caribbean Governments, December 2008, 2. http://cdm.cdera.org/cccdm/2008/cd/data/monday/ccrif/ccrif.pdf (hereinafter Young ART presentation).
28. Swiss Re report, supra note 2, 12.
29. The burden on public budgets is reduced as it makes more economic sense to transfer the risk of the most extreme weather events to the capital markets than to design an infrastructure that can withstand the largest disasters.
30. Id., 13.
31. Young ART presentation, supra note 23, 2.
32. Peterson study, supra note 18, 16-17.
33. Young ART presentation, supra note 23, 2.
34. Id., 3.
35. Young Risk Transfer presentation, supra note 14, 4.
36. The catastrophe bond market operates as follows. "Insurers contract with sophisticated, financial institutions (e.g., an investment bank) to create special purpose reinsurance vehicles (SPRVs) which actually sell and guarantee the bonds to investors. SPRVs also invest in high-rated securities independent of the catastrophe market in order to diversify its portfolio and, hopefully, be able to provide more liquidity to the primary insurer in the case of an insured-against event.
37. Peterson study, supra note 18, 17.
38. Young Risk Transfer presentation, supra note 14, 4.
39. In contrast, there is little or no basis risk with traditional insurance, inasmuch as the actual loss amount can be accurately calculated based on replacement costs of damaged property and business records of revenues prior to the event.
40. Bailey presentation, supra note 1, 18.
41. This basis risk means that events can occur that produce significant losses but no payout (and the opposite is also possible). Because the concept of parametric is not widely or well understood, unrealistic expectations can be developed.
42. Simon R. Young, CCRIF: Background, Update andKey Issues, December 2008, 22. http://cdm.cdera.org/cccdm/2008/cd/data/monday/ccrif/ccrif.pdf (hereinafter Young CCRIF presentation).
43. Bailey presentation, supra note 2, 2.
44. Young CCRIF presentation, supra note 38, 3.
45. In February 2010 CCRIF launched a study on the economics of climate adaptation in the Caribbean region, the Economics of Climate Adaptation (ECA) Initiative. The ECA project assessed the economic impact of climate change in eight Caribbean countries (Anguilla, Antigua and Barbuda, Barbados, Bermuda, the Cayman Islands, Dominica, Jamaica, and St. Lucia). These studies showed that the potential damage from hurricane-induced wind, storm surge, and flooding is already high in the region, with expected losses ranging from 1 percent of GDP in Antigua and Barbuda to 6 percent of GDP in Jamaica. More important, the studies showed that climate change could substantially increase these risks over the next twenty years, with expected losses as a proportion of GDP rising another 1 to 3 percentage points, costing some Caribbean countries up to 9 percent of national income by 2030. In absolute terms, losses could more than double between 2010 and 2030.
46. Swiss Re report, supra note 2, 11.
47. Young CCRIF presentation, supra note 38, 8.
48. Id., 39.
49. Swiss Re report, supra note 2, 10.
50. Young CCRIF presentation, supra note 38, 5.
51. Young Risk Transfer presentation, supra note 14, 5.
52. Young CCRIF presentation, supra note 38, 10.
53. Id., 36.
54. Id., 10.
55. Young Risk Transfer presentation, supra note 14, 3.
56. Id, 6.
57. Specifically, the ability to pool the program into a single reinsurance transaction improved access and pricing, and allowed innovative structures.
58. Young CCRIF presentation, supra note 38, 20.
59. Swiss Re report, supra note 2, 10.
60. Young Risk Transfer presentation, supra note 14, 6.
61. By pooling together all the of Caricom individual risk portfolios rather than each Caricom country having to buy its own insurance through the private reinsurance market, the probable maximum loss for a 1-in-200-year event is reduced by 76 percent for hurricanes and 65 percent for earthquakes, when compared to the aggregate probable maximum loss of each Caribbean country's individual maximum loss.
62. Peterson study, supra note 18, 27.
63. "By pooling together resources, combating individual storm seasons becomes much more financially plausible than otherwise would be possible for a series of small island countries."
64. Young Risk Transfer presentation, supra note 14, 5.
65. Peterson study, supra note 18, 28.
66. Stated differently, by putting contingent funding in place before catastrophes occur, the use of CCRIF "represents a real shift in the way that governments treat risks and the economic costs associated with them.
67. Swiss Re report, supra note 2, 10.
68. Young Risk Transfer presentation, supra note 14, 7.
69. Swiss Re report, supra note 2, 10.
70. Bailey presentation, supra note 1, 9.
71. Id., 10.
72. Swiss Re report, supra note 2, 10.