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Don't let the weather disrupt your business

Parametric insurance is one way to get more comprehensive coverage.

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A satellite handout showing Hurricane Willa on Mexico's Pacific coast on Tuesday. The frequency, severity and economic losses from natural disasters have risen.

WHEN it comes to the Asia-Pacific, it is not hard to observe that the frequency and severity of natural catastrophes impacting the region is increasing. According to UN data, the number of natural disasters in the region has increased from an annual average of 44 in the 1970s to 146 in the 2000s.

From Typhoon Mangkhut that swept through the Philippines and Hong Kong and this year's floods and heatwaves to the recent typhoons Jebi and Trami devastating parts of Japan, the region has been faced with more extreme weather events. On top of this, the earthquake and tsunami that left Palu in Indonesia devastated is still very fresh in our memories. According to Swiss Re's 2018 sigma report, economic losses from natural disasters in Asia in 2017 alone were an estimated US$31 billion, of which only US$5 billion were covered by insurance.

Another observation from the sigma report is that while globally, the number of NatCat (natural catastrophe) events has fallen since 2005, the global total economic losses from these events effectively doubled from US$166 billion in 2016 to US$330 billion last year, and the protection gap between insured and uninsured losses continues to widen.

COSTLY INSURANCE LOSSES

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Many mega cities in Asia, defined as having more than 10 million inhabitants and hosting important commercial, manufacturing and logistics hubs, are located in the Philippines, China, Japan, India, Indonesia and Bangladesh - which are all highly exposed to natural perils.

For example, Cyclone Debbie in Australia, Typhoon Hato which ripped through China, Vietnam and Hong Kong, and Typhoon Lan (Paolo) which affected both the Philippines and Japan, all feature in the top 20 most costly insurance losses of 2017. The earthquake in Palu, Indonesia, crushed hotels, shopping malls and countless houses, while tsunami waves as high as six metres scoured its beach front shortly afterwards.

With Mother Nature becoming increasingly unpredictable, awareness and media attention around the increasing risks relating to climate change are at an all-time high. Particularly in areas regularly hit by natural catastrophes, consideration should be given to the economic consequences of the natural disasters and how business as a whole will be affected directly and indirectly when choosing an appropriate insurance programme.

Conventional business-interruption insurance policies, while covering revenue losses arising as a result of damage to physical assets, typically do not provide sufficient cover in the event of wide area damage and the wider economic losses as a consequence of the event itself. Loss of attraction, supply-chain disruption or airspace closures are just some causes that are not covered by traditional business-interruption insurance. We see companies today beginning to review their insurance cover through a new lens - looking for ways to fill in gaps and complement their existing insurance programmes. With the potential of natural catastrophes to cause wide area damage leading to high non-damage business interruption (NDBI) losses, parametric insurance is a logical solution.

CASE STUDY: AIRLINES AND AIRPORTS

In recent times, airlines and airports have been hit by very disruptive natural catastrophes. Volcano eruptions, harsh winters and widespread flooding have caused major financial impact to both and added stress to passengers. The common denominator of these events was that business suffered although the insured assets sufffered no physical damage. The consequences of such events include reduced revenue, a stranded aircraft (often in the wrong places) and reputational damage, while operators still have to cover the fixed operational costs.

A large international airport was looking for protection against a range of specified NatCat and man-made events worldwide that would cause loss of revenue, and which would provide an easy pay-out calculation against clear and tangible triggers. In this case, atmospheric, meteorological and seismic conditions were included. The solution was a "7-excess, 7-days cover". Following a disruptive incident and resulting closure of airspace or the airport, the cover is triggered on the seventh day of closure, where the airport would receive payouts for the next seven days with an option to extend cover for an extra seven days.

The protection helps stabilise earnings and provides quick cash relief. Compared to debt, the insurance solution is more cost effective and includes no payback on a loan, as well as no covenants. If publicly communicated, the cover also provides transparency on risk mitigation to analysts and investors.

A resort hotel was hit by Cyclone Pam in 2015 as it swept across the Pacific islands causing widespread devastation. Their policy provided cover for the loss of gross profit over a maximum indemnity period of 36 months and while the hotel was restored in June 2016, turnover did not return to pre-loss levels for a considerable time thereafter.

Tourism is an important part of the economy and as a result of the widespread damage, there was a significant dip in visitor arrivals. Therefore, the overall financial impact suffered by the hotel was to a large degree a result of the loss of attraction and falling visitor numbers, deterred by media coverage of the cyclone, as well as issues with the local airport runway, which resulted in reduced flights to the island.

The occupancy rate of this hotel, one of the largest on the island, is closely correlated with the number of visitor arrivals. The official tourism statistics from the government were thus used as a proxy to structure a parametric insurance solution to cushion the business against loss of attraction as a result of a NatCat event.

While a conventional policy would only cover the direct financial impact and adjust downwards for the general market sentiment, a parametric solution offers protection against the broader exposure including loss of attraction.

This illustrates another case where parametric insurance can effectively complement traditional business-interruption policies and fill the protection gap of businesses.

MAKING A DIFFERENCE

Parametric insurance solutions can provide cover and convenience that conventional insurance products do not offer. These index-based solutions insure the probability of a pre-defined event occurring and will pay out an agreed fixed amount when such pre-defined conditions are met (for instance, the magnitude of an earthquake or wind speeds in the event of wind storms).

It is transparent and payments are made promptly, normally within a few weeks. This provides claims certainty and quick access to liquidity for the insured. That can make all the difference when businesses are trying to operate as normal in the event of natural catastrophes.

  • The writer is head of Innovative Risk Solutions at Swiss Re Corporate Solutions.