June 23, 2022

Demex and Guy Carpenter

Insights on Parametric Coverage for Climate Resilience

Ed Byrns, Founder

In May, I had the privilege to talk about parametric insurance and climate risk as part of Guy Carpenter’s panel on  “Parametric Coverage: Addressing the Risks of Climate Risk Transfer” at the firm’s Segment Seminar 2022.

The Demex team is excited to work with Guy Carpenter, a global leader in the reinsurance and risk management space, as we mutually drive new conversations for adapting financial and insurance coverage for climate resilience. With changes in extreme weather, it’s time to start thinking about new options in risk management. I shared our take on the role of parametric insurance as a new, innovative solution in climate risk transfer.

To watch my presentation, click here or check out the video below.

I will take the rest of this post to synthesize our view on parametric insurance for climate risk.

Climate change is causing weather patterns across the globe to become more volatile. Extreme weather events are becoming both more frequent and more intense in many locations while some locations are becoming more tranquil.

Cats and Kits

Traditional insurance and reinsurance focus on natural catastrophes, with coverage known as “catastrophe insurance.” These catastrophes, or “cats,” have a severe impact but are infrequent events, like hurricanes.

Traditional reinsurance often ignores lower severity but higher frequency weather events such as extreme heat, cold, rainfall, and snowfall. These non-catastrophic extreme events are known as secondary perils, also called “kittens,” or “kits.” Gaps in coverage for kits limit comprehensive risk transfer and climate resilience.

At Demex, we view kit losses differently. For example, we built a proprietary extreme weather index by calibrating multiple weather hazards to insurance claims. This index explicitly allows us to structure coverage for lower impact but higher frequency weather events.

Demex and Guy Carpenter charted client claims alongside multi-peril severe weather.

The Mezzanine

Demex is bridging a gap in climate risk. We call it “mezzanine coverage.” It’s like the middle floor between the ground floor and a higher level. This coverage sandwiches the middle for additional support.

Reinsurers don’t provide this coverage because they are averse to increased weather volatility, which makes it harder for them to price risk. They know losses are rising in the lower layer but they are focused on protecting profitability in their catastrophe lines at the top of the stack. They tend to push kit risk back to their client.

Demex has the expertise to accurately assess, confidently price, and then immediately place risk in the mezzanine level. This opens new lines of business for supplemental, non-traditional reinsurance while affordably protecting the client.

Currently available risk management leaves a climate “protection gap” at the mezzanine layer between re-insurance for catastrophes and retained losses from extreme weather.

Demex incorporates data at almost every point on the globe. We use this data in conjunction with bespoke client financial information and calibrate a comprehensive model assessment of climate’s impact on a client’s losses.

Parametric coverage then provides customized options for managing risk. Parametrics are formulaic methods for creating coverage. When weather measurements like temperature, rainfall, or snowfall reach a certain threshold, parametric policies automatically pay claims. Claims correspond to the severity of the weather event. Our parametric models closely track actual portfolio losses, but are not indemnity based.

A simulation of potential losses to insurers by year shows the role of the mezzanine layer between the insurer’s retained losses and the reinsurance layer. The y-axis shows the number of simulated years corresponding to losses across the x-axis. Mezzanine protection closes the gap between insurance losses and re-insurance layers.
An example of the fit between actual client claims (green line) and a parametric model (blue bars) for a portfolio of 300 locations.

Our Approach

The Demex approach to climate resiliency is three steps: first model it, then assess it, and finally manage it. We capture weather exposures with custom models, assess how weather variability affects client economics, and then offer comprehensive risk management programs to address that climate risk.

Demex and Guy Carpenter work together to provide guidance and build programs to cover climate-related risks.

Check out our full panel discussion by clicking here or watching below: