Moody’s Muir-Wood: Social and economic inflation make parametric covers appealing

Moody’s Robert Muir-Wood believes parametric coverage has a “big future”, with the executive also highlighting ways carriers can help overcome issues with basis risk.

Muir-Wood, who serves as chief research officer, insurance solutions at Moody’s, told The Insurer TV that the challenges facing the industry illustrate the benefits of parametric coverage.

“[Indemnity-based insurance] ends up paying for a lot of inflation in the costs of claims. It’s very slow to work it through. It can be very complicated to try and calculate all the ways in which it is going to affect your bottom line,” said Muir-Wood. He also highlighted the cost of litigation abuse.

Parametric policies settle based on pre-agreed indices. As a result, claims tend to be paid more quickly – often within a month – and are less affected by economic or social inflation.

One issue with parametric coverage is basis risk, Muir-Wood explained. “A government can live with the fact that what they get paid is not always going to be exactly the same as what they’ve lost. That probably applies to a business. It is more of a challenge for an individual homeowner to live with that.”

Muir-Wood described how Japan’s earthquake insurance system for households pays claims that approximate the damage experienced. “After an earthquake, they [categorise] the level of damage to a property in terms of five bands.

“So they don’t calculate that it’s exactly 26.4 percent [damage]. You’re in a band of 20 to 30, 30 to 50, whatever, and then you get paid out the midpoint of that band. And actually, you live with the understanding that what you get paid is probably not exactly what you suffered, but overall it’s going to be an equivalent.”

Muir-Wood also discussed how hybrid products with both parametric and indemnity-based elements can help customers live with basis risk.

The wider adoption of parametric covers is “all down to people testing out new products”, said Muir-Wood. “What I think would be interesting is to find somewhere where there’s an indemnity coverage at present and run in parallel with it a parametric.

“At present we have a situation in California [with] earthquake: there may be a 15 percent deductible, so you’re not going to be paid 15 percent of the value of your property, in which case it should be possible to come up with a parametric product which is much more generous and which is competitively priced.”

In this case, you could “let the most successful form of risk transfer win”, he argued.

Addressing the protection gap

Parametric products also have a role to play in closing the global protection gap, with Muir-Wood estimating that 20 to 30 percent of the total gap represents areas where parametric solutions could help.

However, “we have to accept that poverty and low income are part of that protection gap,” he said. “It’s hard to do anything about that except grow the economy.”

Watch the 12-minute video to hear more on: