Parametric Insurance in Latin America: Innovative concepts close insurance gaps
Until few years ago, parametric insurance covers only had a niche existence. Today, with the increased use of data analytics, they are leading the way when it comes to closing coverage gaps. This pays off especially in underinsured regions like Latin America, whose strong agricultural sector is exposed to many weather-related risks.
Christoph Aschenbrenner, Senior Property Underwriter for Latin America at Munich Re, and Brigitte Engelhard, Senior Underwriter for Agricultural Insurance in Latin America, explain why parametric products complement traditional coverages in the best possible way - while innovatively pushing the boundaries of insurability.
What risks does Latin American agriculture face?
Can you tell us how parametric insurance is helping close these gaps for insurers?
Aschenbrenner: Parametric solutions are a very efficient mechanism for assisting strategies to reduce the insurance gap. Underserved segments, such as low-income groups, have difficulties finding suitable conventional cover. A possible holistic solution, one that reflects the different needs of clients after an event, is providing lump-sum payments via parametric covers after an event. Parametric covers settle claims based on pre-defined triggers and payout schemes allowing a simple and quick pay-out process.
Engelhard: In many countries, there are multi-peril crop insurance policies that include coverage for drought and heavy rain, among other risks. However, in countries such as Argentina, these risks cannot be insured, or only to a limited extent. Another example: Because of the comparatively high cost of administration and claims assessment, small farmers do not receive multi-peril crop insurance in a traditional insurance setting. There are parametric approaches to close these gaps.
What other advantages do parametric solutions have?
Aschenbrenner: By allowing quicker cashflow after an event, we effectively enable communities to recover more quickly than they would otherwise. This happens also because the process is very transparent, as independent third parties provide the data needed to trigger payment on a simple and verifiable process such as wind strength or rainfall. This allows us to achieve financing for customers with a high credit risk who would normally have difficulty obtaining conventional coverage.
Let me give you an example: In the state of Quintana Roo, Mexico, Hurricane Delta left severe damage on the coast of Cancún in October 2020. Two weeks later, the claims were reported and just seven days later, the insured were paid the compensation payment. We would have never achieved this speed of payout with traditional covers!
Engelhard: Parametric solutions offer the possibility of insuring previously uninsured producers: smallholders can be insured via aggregators, i.e., municipalities, districts, banks, or input providers. Large producers or corporates can benefit if they want to have coverage tailored to their individual needs. And it facilitates loss estimation when traditional loss adjustments in the field are too burdensome. But what is important for us is that parametric solutions are not designed to replace but to complement traditional insurance programs.
Parametric solutions in the form of cat bonds have been around since the mid-1990s. Why did it take so long for parametric insurance to become en vogue?
Aschenbrenner: Cat bonds were already successful in providing alternatives to property catastrophe reinsurance. Weather derivates to protect against extreme weather have been available for some decades. But in general, parametric solutions tended to be a niche product. This changed when the insurance and reinsurance industry deeply expanded its knowledge in the field of data analytics, data reporting and new modelling techniques. The digital landscape has only recently been able to deliver the optimal conditions to take full advantage of the value they can deliver.
The use of new indices and parameters made it possible to be where we are now. Today, parametric insurance covers a broad range of risks and sizes.
Engelhard: With today’s data-analytical possibilities we are able to manage the complex structuring of parametric products in the agricultural sector: in agriculture a loss not only depends on the amount of rain, for example, but also on the crop insured and on the point of time when the rain falls. The Brazilian government, for example, has realised the improved quality of parametric products and therefore subsidises premium payments for parametric cover in agriculture.
What are the possible reservations about parametric insurance?
Engelhard: The basis risk plays a major role. The basis risk is the case when the trigger-index misses the risk-exposure For example in the case where damage has occurred to the farmer but this is not depicted in the parametric product: e.g. a local rain event occurs but it did not reach the assigned weather station. We can reduce the basis risk with higher resolution through better remote technology such as satellites. This leads to a better acceptance of parametric insurance.
Yet many farmers still fundamentally distrust satellite imagery, preferring to see a loss adjuster in their field.
Are there any outstanding examples of innovative solutions?
Aschenbrenner: In 2020, Munich Re launched, together with Super Seguros Mexico, Seguros Atlas and ERN as the local cat modelling agency, the first of its kind direct-to-consumer parametric earthquake insurance in Latin America with large potential for scalability. Purchasing, administration, client relationship and loss payment is all handled online.
Also, for hurricanes we were a first mover, having launched, together with our partners Raincoat and Optima Seguros, a parametric hurricane insurance in Puerto Rico.
Engelhard: We actively support our customers in the development of new products. The Munich Re Agro team has a strong innovative focus. For example, we have developed future product ideas together with our customers in two Agro-Future Labs in Munich and in Mexico.
We were also significantly involved in the development of the first drought index product for Argentina. This uses satellite imagery to first identify the plant using its spectral signal (classified by a data provider's algorithm) and, then – in the sensitive phase – measure its "greenness", which is a strong indicator of the final yield. If this falls below the trigger, there is a payout.
And we worked with a client to develop a parametric product for drought and heavy rainfall in which rainfall is determined in a multi-step process using CHIRPS data ("Climate Hazards Group InfraRed Precipitation with Station data") with estimates of precipitation from satellite observations and weather station data. If precipitation is above or below the trigger, there is a payout.
Can you give us an outlook for the future?
Aschenbrenner: We are seeing sharply increasing interest in climate-related risk transfer instruments. Climate change and climate-related events like El Niño/La Niña are having a major impact on industries like energy and agriculture, but also the banking sector is exposed to various climate change-related risks that directly affect balance sheet volatility or land-devaluation risk.
Overall, we will move forward working on data analytics and product innovation. Developments like the Internet of Things (IoT) will provide new opportunities as new data sources are available.
Engelhard: Most parametric products in the agriculture sector are currently products based on weather or satellite data. However, many projects are working on reliable yield models that use high-resolution georeferenced data (be it satellite, drone, sensor or others) to enable efficient yield-based index products in the future.