A new way to insure? Parametic insurance pays out the agreed amount if the event happens

Dr Eric Crampton
The Dominion Post
19 April, 2021

Governments have a hard time planning for longer term risks. Unless a specific risk, like climate change, draws voters’ attention, it is more likely to be ignored. There are always more pressing issues of the moment, however trivial. But risks accumulate in the background.

Last week, Auckland Univerity’s Koi Tū released a report by its chair, Former Chief Science Advisor Sir Peter Gluckman, and Dr Anne Bardsley. The report, “Uncertain but inevitable”, explained why governments have a hard time dealing with rare but foreseeable events.

Gluckman and Bardsley propose process improvements in government to encourage better preparedness. But it may be risky for individuals and businesses to bank on the public sector getting better at this.

Finding better ways of insuring against some of what New Zealand’s geology likes to throw at us may matter. Government will not always have our back.

And existing insurance options do not cover all the risks.

After the Christchurch earthquakes, some business owners found business continuity insurance did not provide cover against acts of Council. If Council ordered your business closed because the neighbouring building was risky, or because of cordons, your policy might not pay out.

Estimates of the losses could also prove tricky: the insurer could argue that you had lost customers not because you were unable to trade, but because everyone had stopped going downtown.

Lengthy claims adjudication processes would see homes rebuilt, but with substantial uninsurable anguish imposed on homeowners along the way.

Parametric insurance is a relatively new concept. Rather than requiring loss estimates after an event, which can be lengthy and contentious, parametric insurance simply pays out the agreed amount if the event happens. It is a bit more like a life insurance policy.

These kinds of products solve a lot of problems.

With traditional insurance, insurers have to worry about whether claimants have really been diligent in avoiding losses, or whether claims are overegged. Loss adjustment then must be careful.

Claimants can worry that careful contract wording too easily provides the insurer with ways of avoiding paying at all in a major event. And even without those problems, a years-long process for resolution is rather less than ideal.

Parametric products are much simpler. They are common in North America for crop insurance. Rather than forcing anyone to try to estimate the cost of a heavy frost for an orchard, the insurance simply pays out if temperatures drop below the trigger levels. And larger payments for harder frosts are possible as well.

These kinds of products are exceptionally well suited to earthquake risk.  

A major earthquake on the Alpine Fault is overdue. And, every year, there is about one chance in 120 that Wellington will get to enjoy an earthquake as large as the 2011 Christchurch quake.

In that kind of scenario, it is hard to say exactly what losses any of us might experience – but they will be substantial.

If you own a downtown business, will your loss come from the building’s failure? From a neighbouring building’s failure? From Council cordons around downtown that could easily last for a year? From depopulation? From blocked transport routes?

Your homeowners’ insurance could see your house rebuilt, after a lengthy process, or a cash settlement, which may be rather less than you had hoped for if there is argument about the extent of the damage.

If your job shifts out of town because your employer is leaving, you may be trying to sell a broken house along with its insurance claim, in a hurry, at the same time as many others are trying to do the same. If your home is your biggest asset, the loss will be substantial and is both uninsured and uninsurable.

A parametric insurance product does not care about the nature of the loss or about measuring its extent. If the insured event happens, payment comes quickly.

Unfortunately, those wanting parametric earthquake insurance have had no options at all, until this year.

Bounce Insurance this year began offering small amounts of parametric insurance cover. The policies are based on ground-force acceleration in your neighbourhood, with higher premiums in parts of town with bigger risk. Homeowners can purchase policies providing up to $20,000 in coverage; business owners can insure for coverage of up to $50,000. They promise payment within days.

These kinds of policies would assist homeowners and businesses with a lot of the costs they would face in the early days after a substantial earthquake. And as many who experienced the Christchurch earthquakes will attest, getting that money quickly can matter.

Unfortunately, more extensive coverage against truly catastrophic events is not yet available, and it is likely due to lack of demand. Wellingtonians who have not lived through Christchurch may not really appreciate just how underinsured they are.

Governments have a hard time thinking about low-probability high-cost events. But government and council are preparing, somewhat, for the inevitable Wellington earthquake. The rest of us could stand to think a bit harder about it too.

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