January 3, 2020

Climate change will heighten focus on parametric insurance in Australia

Issue remains over whether products should be characterised as insurance or derivatives

Parametric insurance products have become established internationally as a significant product segment, with some estimates of global parametric gross written premium reaching USD 5 billion, with expectations that this will grow by up to 9% year on year.

Parametric insurance products may also be specifically attractive in the Australian market due to the nature of payments under these policies, which are generally structured as pre-agreed sums or calculated based on an index but informed by objective and measurable external data such as the speed of cyclone or hurricane winds. As the criteria is objective and measurable, these products allow insurers to service remote locations and increase speed of claims payments compared to traditional insurance products in which the loss would have to be proved by the policyholder.

With the large geographic distribution of population and risks in Australia, and areas which are susceptible to increased risk consequent to climate change, the advantages of parametric insurance products will drive substantial growth for these products in Australia.

With the growth of this market, however, Australian regulators will need to grapple with the nature of parametric products in the same manner as regulators globally have had to. As parametric products do not react to loss in the same manner as traditional insurance products, these products can arguably constitute insurance products or capital markets products, namely derivatives.

Given that parametric products by their nature contain certain indicia of a derivative arrangement but nonetheless as a whole may have the provision of insurance as their principal objective, regulators are likely to have to assess each individual product to determine whether they are more appropriately categorised as insurance products or derivatives. Given the likely continued growth in this market, however, regulators will have to determine their approach sooner rather than later.

Read the rest of our insurance predictions here.