Panel Discussion Sheds Light on Parametric Coverage and Regulatory Challenges

In a recent panel discussion at the Vermont Captive Insurance Association's Annual Conference, experts delved into the nuances of parametric coverage and how it differs from traditional insurance. The panelists provided valuable insights into the world of parametric contracts, their growing popularity, and the regulatory challenges that come with them.

Understanding Parametric Contracts

Parametric contracts are index-based agreements that aim to provide coverage based on predefined indices. These indices can be linked to various factors, such as rainfall, temperature, or earnings growth, which act as indicators of potential losses in a given context.

Derrick Easton of WTW explained that parametric contracts offer a number of advantages. They are highly flexible, simple to understand, and typically exclusion-free, reducing the chances of disputes. These contracts require that losses are certified before claims are paid, making them a quick and efficient solution to address various forms of loss.

Mr. Easton said a key difference between parametric coverage and traditional indemnity-based insurance is the approach to losses. Parametric coverage focuses on specific triggers and indices, ensuring swift payouts in the event of predefined conditions, while traditional insurance policies involve complex loss adjustment processes and are subject to exclusions, deductibles, and lengthy claims settlements.

The Role of Parametric Coverage in Corporate Risk Management

The discussion also highlighted the growing interest among corporations in utilizing parametric coverage to manage their risk portfolios effectively. As the insurance market experiences a hardening cycle and limitations in capacity, companies turn to alternative risk solutions. Parametric coverage offers a way to address gaps in coverage and respond rapidly to losses without the hassle of lengthy claims processes.

The panelists emphasized the importance of understanding and quantifying exposure when considering parametric coverage. Companies should collaborate with their actuarial teams to assess their risk appetite, exposure levels, and potential savings that can be reinvested into their balance sheets or used to explore parametric products.

Brando Soto, Boston-based senior director, insurance and risk management, for Vertex Pharmaceuticals Inc., and Torreyana Insurance Company, Inc., a Vermont-domiciled captive insurance company, said finding property cover in 2019 was a major challenge that prompted his organization to review its actuarial risk modeling and undergo a multiphase process to better understand its business interruption exposure relative to flooding as well as some of its calculated exposure.

Going down the path of structured or alternative risk transfer requires close work between an organization's internal teams to understand overall exposures across the company. If an organization determines it can sustain more of its own losses, premium savings may be achieved from the direct or reinsurance markets through increased retentions. Parametric products are a way to complement and support a captive insurance program, said Mr. Soto.

One of the upsides to parametric coverage, according to Mr. Soto, is that payout happens within a matter of days versus weeks involving complex claims litigation. On the downside, if an organization does experience an event, it is possible that the parametric contract will not be triggered, he said.

Challenges and Regulatory Considerations

One of the major challenges is basis risk, according to Mr. Easton, which can be inherent in parametric products. However, he argued that there may be more basis risk in traditional indemnity policies due to complex terms, deductibles, sublimits, exclusions, and loss adjustment processes.

The regulatory landscape for parametric coverage is evolving, with different domiciles taking different approaches. In Vermont, regulators have been proactive in allowing parametric contracts within the boundaries of existing insurance code but are continuously working on clarifying their stance and intent to provide clear guidelines for organizations.

Accordingly, Vermont updated its captive laws to include a provision specifically allowing Vermont-domiciled captive insurance companies to enter into parametric risk transfer contracts.

The panelists stressed the need for collaboration between the industry and regulators to ensure that the regulations adequately address the unique features of parametric coverage. They anticipate future improvements in the regulatory framework to accommodate the growing interest in parametric coverage.