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Parametric policies confront climate risk

Clean energy alternatives

Parametric insurance products are being deployed to support the transition to a low-carbon economy and address a growing concern for the risk management community: the challenge a shifting climate presents for the insurability of their assets.

Policies revolving around parametric coverage triggers are being used to support the financing of clean energy projects that are often challenged by extreme weather events. Capacity at the moment outstrips demand, but that is expected to change as awareness of such policy solutions expands to nonenergy sectors facing increasing threats posed by climate change and as corporations utilize these products in support of their environmental, social and governance goals.

“Parametric insurance has been around as a concept for a generation or more, but it does seem to be having a moment now,” said Nigel Brook, a London-based partner with law firm Clyde & Co LLP.

The U.S. clean energy sector significantly expanded under the Obama administration, which provided more than $90 billion in loan guarantees, tax incentives and other mechanisms to support the deployment of low-carbon technologies through the American Recovery and Reinvestment Act of 2009. But the clean energy sector was still hampered by a lack of familiarity and comfort with the projects by banks and other investors, so parametric insurance is being deployed to ease the financing for such projects, which is often the most expensive cost, experts say.

“Insurers can play that really valuable role in driving down the cost of renewables,” Mr. Brook said.

For example, Hartford Steam Boiler Inspection and Insurance Co., a unit of Munich Reinsurance Co., offers a product that includes lack of sunlight as a parametric trigger, with the insurer compensating the policyholder for financial losses if solar irradiance falls below a predefined threshold.

A similar product aimed at energy efficiency projects includes a form of parametric coverage triggered by a project failing to save a predetermined amount of energy over the course of the policy term.

“Investors don’t have a tremendous amount of experience putting their money behind these types of projects, so anytime they see the opportunity to transfer the investment risk onto the plate of someone like an insurance company, someone with that level of financial strength, it’s almost a no-brainer for an investor, assuming that the price is right,” said John Stokes, an Atlanta-based vice president with expertise in specialty products and solutions for the energy sector with HSB.

Parametric solutions are also being deployed to address problems for clean energy projects created by extreme weather events, experts say. For example, extreme heat waves and low wind speeds are a bad combination for a wind farm, because power prices spike but the wind farm isn’t producing electricity, said Lee Taylor, CEO of data and analytics provider REsurety Inc. in Boston.

Rather than simply being a tool to mitigate the symptoms of climate change, insurers can play a role in tackling climate change by offering these products, he said.

“By more intelligent risk management of projects enabling more wind farms and more solar farms to get built and run profitably and securely, that reduces the climate change impact in the first place,” he said.

Beyond the clean energy sector, parametric insurance can also be a solution to manage climate risks in other industries, experts say. In the Midwest, for example, trends toward warmer, wetter and more humid conditions challenge a region probably best known for its agricultural production, according to the Fourth National Climate Assessment released on Nov. 23 by the U.S. Global Change Research Program. The Midwest also has “vibrant” manufacturing, retail, recreation/tourism and service sectors that could be disrupted by the changing climate, the report said.

Parametric insurance can be deployed to cover climate-related business interruption losses in a variety of sectors, said Karina Whalley, marketing and business development manager for Axa SA’s global parametrics in Paris. For example, a hurricane could prevent people from going to a movie theater or result in hotel cancellations, but these events wouldn’t trigger payouts under typical indemnity policies because the buildings have not been damaged.

A parametric policy designed with a trigger at a certain wind speed, however, could cover such losses.

A growing source of demand for parametric coverage are corporations such as large technology and other companies that have committed to secure 100% of their power from clean energy sources because these products take the risk of potential shortfalls, said Tom Markovic, senior vice president, weather and energy specialty products at Marsh LLC’s MMC Securities in New York.

Currently, though, the supply of parametric insurance capacity for these risks outstrips demand, experts say.

“We would much prefer to take this kind of risk that’s parametrically defined because we can model it much more easily,” Ms. Whalley said. “I think it’s just a matter of time before it’s much more widespread.”

The number of insurers participating in this space depends on the sophistication of the product, Mr. Markovic said. If a wind project developer is looking for a few years of coverage, 10 or more insurers are willing to write a policy; but if the project has a longer tenor of 10 to 15 years or is combined with insurance protection against power price volatility, that narrows the field to three to five insurers.

“But this is a developing space, so I’m sure in a few years we will see 10 of them offering all these complex products or more,” Mr. Markovic said.

Capacity has not been an issue because typical limits could range from $5 million to $50 million annually, which is usually available on a project basis, he said.

“The pricing is commensurate with the risk,” he said. “The pricing and the approach is very actuarial. Some other industries like cyber are hard to model because you don’t have enough data. We have access to data, more and more so, globally.”



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