Part 3
In Part 1 and Part 2, we explored the escalating threat of severe convective storms (SCS), their financial implications, and the critical role of reinsurance in managing these risks. This final section focuses on solutions to address the broader impacts of climate change on the insurance industry and the potential future scenarios for insurers in an increasingly volatile climate.
The lack of reinsurance solutions for secondary perils is not a temporary issue. This is a persistent market problem. Media reports indicate that while reinsurers have stabilized recently stabilized CAT pricing, they are not returning to offer traditional frequency covers. Instead, they expect insurers to retain a larger portion of the risk than in the past. Reports indicate a reluctance from reinsurers to re-enter the frequency cover market due to the significant losses incurred over the past decade.
At Demex, we are taking the lead in addressing this mounting economic impact of secondary perils.
The Advantage of Parametric Structure in RCR Re
Parametric reinsurance solutions are known for having high, sometimes unacceptable, levels of basis risk. However, Demex’s approach to modeling and structuring its parametric solution is materially different—and therefore better—than the vast majority of parametric solutions in the market.
Our Retained Climate Risk Reinsurance (RCR Re) uses a unique stop-loss mechanism based on Demex’s proprietary Proxy Claims Index. This allows insurers to manage the accumulation of claims from secondary perils affordably. By leveraging advanced modeling technology tailored to secondary peril risks, we provide a robust solution to a pressing issue, enhancing economic resilience against climate change.
“Secondary perils are no longer secondary in their impact. RCR Re from Demex is an innovative reinsurance product specifically designed for severe thunderstorms and secondary perils, filling a critical gap in the market.” Bill Clark, Demex CEO
RCR Re offers a parametric solution that insurers need at an affordable price while allowing reinsurers to profit. This is possible because RCR Re’s parametric structure reduces the risks that make traditional frequency covers unprofitable.
A recent report by PwC highlights the challenges and potential solutions related to basis risk in parametric insurance products. Basis risk arises when there is a discrepancy between the insurance coverage and the actual event that triggers a payout, leading to unexpected lower payouts or no payout at all. This risk is inherent in the design of parametric insurance, where payouts are based on specific, measurable events rather than the actual damage or loss experienced.
Several factors contribute to basis risk, including:
- Limited availability of high-quality data: Accurate prediction of insured events is crucial.
- Inaccurate or outdated index triggers: The mechanisms used to reflect events must be precise and current.
- Rigid policy terms: Flexibility in policy design can help better match the insured’s risk profile.
PwC suggests that mitigating basis risk requires a multifaceted approach: (Tailored policies, dynamic indices can help mitigate parametric basis risk: PwC, written by Kane Wells at Artemis)
- Enhancing data quality: Reliable and precise data helps in predicting insured events more accurately.
- Monitoring and evaluating policy parameters: Regular assessments ensure the policy stays relevant to the risks.
- Refining index triggers: Improved triggers can more accurately reflect the occurrence of insured events.
- Diversifying insurance parameters: Offering a mix of parametric and traditional insurance can provide better coverage.
Demex RCR Re is designed to incorporate many of these recommendations to enhance the accuracy and reliability of our parametric reinsurance, addressing one of the significant challenges in the industry. We use each cedent’s historical claims data to train and refine our model, aligning it closely with the cedent’s actual claims history. This minimizes basis risk and makes RCR Re almost as close to an indemnity approach as possible from a parametric perspective.
Retained Climate Risk Reinsurance (RCR Re) in the Market
Despite the retreat of reinsurers from frequency covers, capacity providers are showing interest in supporting Demex Retained Climate Risk Reinsurance (RCR Re).
“In 2023, Demex secured indicative pricing for over $200 million in capacity and anticipates having $500 million to $1 billion in available capacity in 2024. This interest is due to the fundamentally different structure of RCR Re compared to traditional frequency covers. Innovative insurance companies are also at the forefront of this new market. In our first year alone, Demex partnered with the market’s most trusted brokers and their clients to place nearly $65 million in new reinsurance specifically geared toward SCS .” Matt Coleman, Demex Chief Risk Officer
Reinsurance paves the way for resilience against severe convective storms. Our innovative solutions are already making a difference for insurers and their customers who are homeowners and property owners.
Reinsurance is evolving to build resilience to climate change. Our team at Demex is proud to be at the forefront of this change.
Client Calibration: Demex’s Breakthrough Methodology
Demex’s proprietary approach, “client calibration,” allows us to deliver coverage for extreme weather perils that have been significantly underserved by most reinsurance carriers.
Demex solves this problem by calibrating to client financial data, rather than relying upon the statistical assumptions that are common in catastrophe models. First-party financials allow us to accurately measure and model the risk of future losses due to non-catastrophic events that have been observed with increasing frequency across our clients’ operations. The nature of changes in extreme weather resulting from a changing climate are hyper-localized and a client’s particular pain points related to weather perils require specifically localized solutions.
At a high level, the key steps in our client calibration workflow include:
- Ingest Client Geo-Financial Data & Calibrate to Relevant Weather Datasets: We obtain historical financial data from our clients that corresponds to their portfolio of exposure. This data includes customer claims history, geographical identifiers for each data point, and other important metadata.
- Identify Dependent Weather Variables & Train Demex Models: Once data has been loaded and normalized, we develop the models using iterative algorithms and machine learning to identify best fits and ideal combinations of dependent variables.
- Analyze Model Sensitivity & Underwriting Suitability: Additional analysis ensures that the forward performance of the model can be adequately anticipated and is suitable to both the protection buyer (primary insurer) and the protection seller (reinsurer).
- Develop Climate-Conditioned Forward Probability Distributions: Partnering with the protection seller, we develop forward-looking probability distributions that form the basis of the ultimate underwriting decisions, factoring in the impact of climate change.
Our approach to modeling the impact of climate change involves isolating the climate-changed signal and using a series of techniques and percentile rank algorithms to calibrate the distribution and adjust for model risk. This method helps both buyers and sellers make more informed decisions regarding premiums, limits, and attach points for underlying risk transfer products.
Demex’s innovative solutions and client calibration methodology provide a comprehensive approach to managing climate risks, offering insurers the tools they need to navigate an increasingly volatile climate landscape.
Conclusion
Severe convective storms pose a mounting threat to the insurance industry, driven by the accelerating effects of climate change. The financial implications of these storms are profound, challenging the stability and resilience of insurers and policyholders alike. As the frequency and severity of SCS continue to rise, it becomes increasingly critical to develop and implement innovative solutions to manage these risks effectively.
This white paper has highlighted the escalating threat of severe convective storms and their financial impact, drawing on insights from industry experts and examining the vital role of reinsurance. The traditional reinsurance market is under pressure, necessitating new approaches to ensure the industry’s resilience.
Demex’s Retained Climate Risk Reinsurance (RCR Re) represents a pioneering solution, addressing the gaps in coverage for secondary perils and providing a robust mechanism for managing claims. By leveraging advanced modeling technology and innovative parametric structures, Demex is leading the way in enhancing economic resilience against climate change.
As we look to the future, it is clear that the insurance industry must continue to evolve and adapt to the changing climate landscape. By embracing innovative solutions like RCR Re, insurers can better navigate the challenges posed by severe convective storms and ensure a more stable and resilient future for all stakeholders.
Looking ahead, the insurance and reinsurance marketplace must adapt to the realities of increased SCS losses and the broader impacts of climate change. This will likely involve a shift towards more sophisticated risk assessment models, greater collaboration between insurers and reinsurers, and the development of new products that can effectively mitigate and manage climate-related risks. The industry will need to embrace technological advancements and innovative solutions to remain viable and resilient in the face of growing climate threats. By doing so, insurers and reinsurers can not only safeguard their financial stability but also provide more comprehensive and affordable coverage to policyholders, ensuring a more secure future for all.
Read the Overview – Severe Convective Storms: Impact on the Insurance Market