February 2021 – Parachute – Risk Protection Technologies

The 2021 Atlantic hurricane season will officially begin on June 1. With the increase in extreme weather events and the COVID-19 health pandemic, it’s more important than ever to understand your risks and prepare for hurricane season. While the National Oceanic and Atmospheric Administration (NOAA) will not issue its initial seasonal outlook until May, climatologists can still offer a prediction for the upcoming season earlier in the year. The record-breaking 2020 hurricane season was brutal, will 2021 be the same?

What are the predictions?

Early hurricane predictions for the upcoming season typically come from two authoritative bodies, Colorado State University and Tropical Storm Risk (TSR), a consortium of tropical weather specialists based out of the University College London. These two groups meet at the end of each year to discuss their research and provide predictions for the upcoming season. In December, 2020 these two groups met virtually, due to COVID-19, to discuss their initial predictions for the 2021 season. Based on their individual research, both groups agreed that the upcoming season will likely be an above average season, although not as active as the 2020 season.

In a study conducted by Dr. Phil Klotzbach of Colorado State University, his research team determined that there is about a 60% chance of 2021 being another active season. Dr. Klotzbach’s research also found that there is a 68% probability of one or more category 1-2 hurricanes and a 52% probability of one or more category 3-5 hurricanes landfalling along the US coastline. TSR’s research also predicts that North Atlantic hurricane activity in 2021 will be above the long-term normal, but not as intense as the previous season.

What is the long-term normal for an Atlantic hurricane season? As determined by NOAA, from 1991-2020, the average hurricane season produced 14 named storms, of which an average of 7 developed into hurricanes and 3 became major hurricanes. Last year, 2020, was an extremely busy season with 30 named tropical storms of which 13 developed into hurricanes and 12 made landfall on the US coastline.

What factors affect these predictions?

While climatologists can’t forecast the exact number of tropical storms or hurricanes this early in the year, they are able to examine the slow-motion drivers that promote or reduce hurricane activity. The two main factors that determine how active the next season will be are the status of El Niño Southern Oscillation (ENSO) and changes in water temperatures in the northern Atlantic, the Atlantic Multidecadal Oscillation (AMO). These two factors are both related to water, but weather also plays a role in hurricane activity in the Atlantic. Weather patterns are more short-term and will be evaluated as early as April.

El Niño Southern Oscillation (ENSO)

Occurring every three to five years, El Niño Southern Oscillation (ENSO) is an ocean-atmosphere phenomenon that causes an increase in sea surface temperature. La Niña is the colder complement to El Niño that causes the tropical Pacific Ocean to turn colder than normal. A La Niña cycle has caused water temperatures to cool in the Pacific since last summer. A colder tropical Pacific Ocean can influence the entire tropical wind flow and storm steering currents. During La Niña cycles, there is an increase in low-level winds blowing from East to West in the Atlantic. This wind flow scenario promotes the development of Atlantic hurricane activity and pushes the hurricanes toward the United States. The good news is that recent analysis from NOAA suggests that the current La Niña cycle will end this Spring, before the start of hurricane season on June 1.

With no expected El Niño or La Niña cycle this summer, the expected number of Atlantic hurricanes could decrease. Yet, it is important to note that the El Niño ocean-atmosphere pattern is very hard to predict and is only one factor in determining hurricane activity.

Atlantic Multidecadal Oscillation (AMO)

The Atlantic Multidecadal Oscillation (AMO), a climate cycle affecting sea surface temperature, has caused water temperatures in the Atlantic to be naturally above average for the last 25 years. This is crucial to hurricane development in the Atlantic because an enhanced AMO cycle slows down the Bermuda High, the semi-permanent, subtropical area of high pressure in the North Atlantic Ocean located between Bermuda and the Azores during hurricane season. The Bermuda High is largely responsible for pushing tropical waves, storms and hurricanes west away from Africa and toward the Caribbean and United States. If the Bermuda High is rotating slowly, the tropical systems have more time to develop and intensify.

Currently AMO is projected to be at its peak of the average 60-year cycle. As the last five hurricane seasons have been unusually active, higher than normal water temperatures due to AMO is predicted again for 2021. However, AMO can be unpredictable and it’s possible for a year or two to not follow the warm sea surface temperature trend even at the height of the AMO cycle.

What can I do to prepare?

Here are a few actions you can take now to prepare for the upcoming hurricane season:

Ensure your home and cars are stocked with emergency Items include emergency food, water, and medicine supplies.
Create your family disaster plan. Factor in any health or medical concerns, especially for older members of your family and don’t forget to make a plan for your pets as well.
Print or save electronic copies of important documents including emergency phone numbers and insurance information.
Create a financial preparedness plan. Understand what is covered in your current homeowners’ policy and add additional coverage (such as flood insurance) if needed. Add to a savings account to cover the potential short and long-term expenses and any deductibles. Consider parametric insurance as a useful building block for your hurricane preparedness plan. With Parachute Insurance, you will receive emergency cash within hours after a hurricane hit.

For those living in hurricane-prone areas, it’s never too early to prepare. While it is impossible to say with certainty how active the hurricane season will be this year, 2020 taught us to prepare for the unexpected.

Insurance is finally changing. New, reliable data sources, digital technologies, and shifting customer dynamics are the driving forces behind this transformation. Customers are demanding more convenience, faster payments, and affordable, practicable solutions to manage their risks. Climate change and an increasing number of people being exposed to weather extremes make it more important than ever to build climate resiliency.

Parametric insurance is not new. In fact, it has been successfully applied for years in life insurance and in risk-linked securities, such as catastrophe bonds. One of the better-known examples of parametric insurance is the Caribbean Catastrophe Risk Insurance Facility, which was established in 2007. This facility pooled the risk of 16 Caribbean and Central American countries and purchased parametric insurance against weather catastrophes, such as hurricanes, extreme rain and earthquakes.

Driven by the mentioned trends parametric risk management is now primed to go “mainstream” and make a much broader impact to consumers.

What is Parametric Insurance?

The concept of parametric insurance is simple: a pre-defined payment occurs if a pre-defined parameter surrounding an event is triggered. For example, the event could be a hurricane that unleashes winds over a certain speed, the “trigger”. The insurance contract defines the specific parameters (metrics, characteristics, and thresholds) of events that will trigger a payment.

This design has many advantages. As the payment amount is established in advance and not linked to the actual loss, like in conventional indemnity-based insurance, there is no need to adjust the claim after an event. Instead, claims can be paid out almost instantly. This is important as speed is a crucial factor for individuals and organizations to stay resilient and recover after a disaster.

A key requirement for parametric insurance is reliable and consistent data that is highly correlated with an anticipated loss and comes from an independent, recognized, and well-respected organization, such as the National Oceanic and Atmospheric Administration (NOAA) for hurricanes.

Parametric insurance is appealing to many customers because it offers protection and financial support while eliminating everything people dislike about insurance: complicated policy forms, high deductibles, a long-drawn-out claim process, or claim disputes that sometimes end up in court. For example, over 1,250 business interruption lawsuits have been filed in US courts against insurers for claims arising from shutdowns in response to COVID-19.

Where is it Used?

There are many areas where parametric insurance is already used including hurricanes, earthquakes, droughts, excessive rainfalls, floods, extreme high or low temperatures, and many more. Parametric insurance is also starting to see traction for non-tangible losses, such as travel delays, business interruptions, and even power outages. With more accurate data from weather stations, satellite images, and other sensors as well as improved risk modeling capabilities, there will be even more applications in the future.

Several recognized insurance players around the world have already released parametric products. For example, Swiss Re offers parametric products for wind storms and earthquakes. Sompo has introduced parametric crop insurance. And AXA offers parametric insurance for renewable energy, agriculture and the hospitality industry. There are also several new players that offer parametric insurance specifically targeting consumers. Parachute Insurance for instance is developing a parametric hurricane protection product for homeowners.

Benefits of Parametric Insurance

Parametric insurance has many advantages for customers as well as for insurers.

Benefits from a customer’s perspective:

Fast – When a policy is triggered, payments can reach customers almost immediately.
Easy – The policy language is explicit and clear. Customers do not have to file a claim or deal with a claim adjuster.
Affordable – With easier underwriting and practically no claim adjudication, costs can be significantly reduced, making it affordable for many customers.

From an insurer’s perspective:

Efficient – Parametrics offers insurers a chance to reduce their notoriously high expense ratios which has been hovering at around 30% of premiums.
Fast – The value of claims is known almost immediately, and maximum losses are capped, even in a catastrophe.
Growth – Parametrics offers insurers an opportunity to expand into new risks that were previously uninsured or underinsured.

Concerns

Parametric insurance also has downsides, most notable the basis risk and lack of customer literacy.

Basis risk is the risk that a customer suffers a loss but doesn’t receive a payout. This might be due to the fact that parametric insurance only triggers a payment when an index meets a specific threshold, not by the actual loss itself. You can reduce basis risk by choosing an index highly correlated to the actual loss as well as by granular data. Also, it is important to keep in mind that even conventional insurance includes “basis risk” in the form of policy wording with deductibles, exclusions, and limits.

The other concern is consumer illiteracy, meaning consumers might not fully understand the payout process of a parametric product. It is important to stress that parametric insurance is not as comprehensive as traditional insurance and is therefore often marketed as a supplemental cover.

Why Now?

Until recently, mostly governments and large corporations were buying parametric insurance, but it is now gaining momentum for smaller businesses and individuals. The rise in parametric insurance can be attributed to a few connecting factors. Customers are demanding easier insurance products with faster payouts. With more frequent and intense natural catastrophes, there is a growing need for more affordable risk management solutions. Finally, new data sources make it possible to develop new parametric insurance products. When designed well, parametric insurance products can help satisfy many of these customer needs and keep the insurance industry evolving with the times.