Special Edition: Preparing Business for Changing Weather

Special Edition: Preparing Business for Changing Weather
September 25, 2024 12 mins

Special Edition: Preparing Business for Changing Weather

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Special Edition Episode: Aon experts explore a powerful tool for weather risk: parametric insurance.

Key Takeaways
  1. In this episode, Aon experts discuss steps for the practical application and implementation of parametric insurance.
  2. Aon’s experts share the key questions linking parametric insurance and the management of weather risk.
  3. This episode provides insights on how these policies are becoming increasingly important to businesses.

Intro:
Hi everyone, and welcome to the award-winning “On Aon” podcast, where we dive into some of the most pressing topics that businesses and organizations around the world are facing. Today, we hear from Liz Henderson for a closer look at one of the four key client megatrends impacting organizations around the world: weather. Now, please welcome this episode’s host, Laura Wanlass.

Laura Wanlass:
Hello, everyone. My name is Laura Wanlass. I'm a partner and leader of the Corporate Governance and ESG team within Aon's Broader and Executive and Board Advisory Practice. In today's special On Aon episode, we're taking a closer look at a key concern among leaders of all backgrounds: weather.

Now with 2024 already lining up to be yet another year of extreme weather events, business leaders are increasingly examining the impact of wildfires, floods, and storms on their organizations, people, and infrastructure. In fact, according to Aon's Global Risk Management Survey, four of the top 10 global risks, business interruption, regulatory and legislative changes, supply chain and distribution failure, and damage to brand or reputation are all impacted by weather.

Plus, earlier this year, Aon released the business decision maker survey. We talked to 800 C-suite and business executives in North America, UK, and Europe, about the risks and opportunities arising from four key client megatrends impacting organizations around the world. These are trade, technology, weather, and workforce. And when it comes to weather, the survey found that decision makers are getting more and more involved in climate and weather strategy.

But business leaders may be slower to act on weather risk versus other types of risks. And that might be because it's a tough challenge on a lot of different fronts. Changing weather can affect the health and safety of workers and create new risks in terms of understanding emerging global regulatory changes. And even in how best to leverage emerging green technologies as part of the overall strategy.

But the one solution that is set to become more important than ever in the coming years is parametric insurance. This critical tool may help bridge the protection gap in areas hit hard by extreme weather. So, with me today to discuss more on this topic is Liz Henderson, Global Head of Climate Risk Advisory. Thank you so much for being here today, Liz.

Liz Henderson:
Thank you so much for having me here today, Laura.

Laura Wanlass:
Okay, great. In our discussion, we're going to walk through several important questions about the linkages between parametric insurance and the management of weather risk. So with that, let's get started, Liz, first with some baseline questioning. Can you tell us a little bit about, how do parametrics work? Why are they becoming increasingly important to businesses? And how do they provide additional coverage that might help hard-hit communities?

Liz Henderson:
That's a great question and it's interesting because I do think that parametric products have been around for a pretty long time in the insurance space. But there's still a real lack of awareness or lack of understanding of how they actually work, and how they can actually complement your traditional insurance solution that your organization is using to address volatility. And so, it's really important to continue to talk through the baseline, how do they work? Why would an organization want to use and utilize parametric coverage rather than traditional coverage?

The way that I think about it is that parametric products at their very foundation, they are a hedge against particular types of events occurring. So, when you purchase a parametric product, you don't have to prove a certain amount of loss above an insurance deductible. You don't have to have a claims adjuster come out and understand how much damage you experienced after an event. The event itself will trigger the payout of the product. For example, if you purchase a parametric product that covers hurricane, it might trigger based off of the wind speed recorded by the National Hurricane Center at a particular location. And if the National Hurricane Center says, "yes, this event hit this wind speed in Miami, Florida," you're going to get a payout based on the terms of the product you've purchased.

And why that's really attractive to organizations is because there are many sources of volatility related to natural disasters that are not directly or easily quantifiable in an indemnity product. Things like business interruption when you don't have a lot of damage to your property or sometimes even no damage to your property. But you're still being impacted because the general area is impacted after an event, you can purchase something like parametric coverage to protect you against that business interruption loss.

The other thing I think about around parametrics and how they can expand your recovery ability, is that they are very quick to pay out. Because you don't have to have a claims adjuster come and survey a property after an event, the payout time period is much, much faster. The reporting trigger will be identified, the terms of the contract will go into play, and the settlement amount will be paid out in sometimes as quick as 30 or 45 days after the event occurs. So, that really helps communities and organizations who need cash quickly in their hands in order to return to full operations or to support recovery efforts. That speed is really key and a defining component of parametric coverage. So, it's that flexibility, that quick payout, the transparency around the trigger, and how the product will pay out or not makes it really ideal to help bridge that protection gap.

Laura Wanlass:
That was incredibly helpful, Liz. You've provided a lot of advantages about how parametrics work and how companies can utilize them. So, let's build off that context you just provided. What does the protection gap look like right now in the face of increasingly extreme weather? And how can parametrics specifically help address this protection gap?

Liz Henderson:
That's a great question. And first let me just define, what does the protection gap even mean? It's a term that we use quite a bit in insurance, but what it actually means is the amount of uninsured loss, economic damage that has occurred that insurance is not picking up. So for example, if an earthquake occurs in Turkey, the total economic damage from that event will include all of the physical damage. It'll include all of the recovery efforts, it'll include things like downtime, impacts to health and life. But insurance only picks up certain portions of those losses. And so, that gap between what insurance covers and doesn't cover is the protection gap.

When you look at the data that we track and calculate every year, on average, that protection gap has hovered around 62, 65 percent, meaning that 65 percent of global economic losses are not covered by the insurance industry at all. That means they're picked up by aid organizations, by government payouts, by individuals, homeowners, and community owners who are having to pick up the rest of that bill in order to recover after events.

There's a lot of reasons why that protection gap exists. You can see in places of the world where insurance doesn't have a lot of penetration, that the protection gap would be much, much wider. There are certain parts of the world and certain perils where insurance is really available and easy to price, and there's a lot of capacity. So depending on the peril and the part of the world you're looking at, sometimes the protection gap will look a lot lower and sometimes it'll look a lot bigger.

And so, where parametric can really come in is when you identify places where that protection gap is quite big. And there isn't really a viable insurance product or enough insurance capital that on its own, could go in on an indemnity basis to fill that gap. So, parametrics often are the solution in that part of the world.

So as a recent example, Aon worked with the government of Puerto Rico in 2023 to create a government-sponsored parametric transaction to help Puerto Rico reduce its dependency on U.S. FEMA payouts after events. So, the product provides cover against hurricane and earthquake. And will help to complement and enhance the FEMA money after an event that Puerto Rico would get, and really allow them to be able to recover more quickly.

Laura Wanlass:
Yeah, that's a great case study application of how the protection gap works and how this can provide sufficient coverage and strength in a tough time with climate events ramping up. Okay. With that information, it's pretty clear that parametrics can be an important tool in a business toolbox, but let's get really practical here. For risk managers or anybody in the org that's thinking about mitigating climate risk and weather risk, how can an organization get started with parametrics? What's involved, who's involved?

Liz Henderson:
Great question. And I think as with any leading company and leading risk manager, the way that Aon works with our clients is to create a holistic, data-driven framework that they can use to evaluate the various insurance products that are available to them. So while this focus is on parametric and how valuable that can be to fill the gap, we also know that clients have to have a understanding first and foremost, of the risk that they're actually facing in a holistic basis. So, do you understand your natural catastrophe, acute event risk? Do you understand how more chronic perils like sea level rise, extreme heat, extreme precipitation, how are those things affecting your business from both a direct damage perspective, but also a broader operational perspective as well?

Once you have that understanding of your baseline risk, then we can work with you to really think holistically about the sources of capital and the types of insurance product that can come in and identify or fill in that risk transfer need that you have. So, for example, if you have data that tells you your hurricane risk is quite high and we think it's going to change over time, you might decide that parametric is not necessarily the right solution. Because there's a lot of insurance capacity available for hurricane risk, especially in North America. But if you also see that sea level rise and extreme precipitation is going to affect your ability to maintain operations over a longer period of time, then something like parametric might be able to come in and cover that gap, cover that area where there isn't as large amount of traditional insurance coverage available. But parametric can really be a great solution.

The other thing to start asking yourself too is to really get that holistic view of how these events and how weather is going to affect your operation. It isn't just about physical property damage anymore. Weather affects all aspects of your business. Heat is a great example of this. Extreme heat affects not only people's lives directly, but also productivity and people's ability to show up at work and to continue to perform at the levels that you need them to.

In addition to that, there are more labor regulations coming out that actually tell companies how they have to respond to and protect their employees against extreme heat events to make sure that they're productive and healthy and able to continue to operate at their highest level of potential. There isn't really an indemnity insurance product that covers that risk that you have. Parametric is a great solution for something like extreme heat that is going to affect our organizations outside of physical damage, but is directly tied to the changing weather and the impact that climate change has on weather trends.

Laura Wanlass:
Okay. Well, great. Thank you so much for joining us today, Liz, and making this such an interesting and navigable topic for companies. And with that, that's our show for today. Thank you all for listening, and in the next few months, we'll have more special episodes focused on other megatrend areas of trade, technology, and workforce. So, with that, until next time.

Outro:
Thanks for tuning in to the latest episode of “On Aon” with our episode host, Laura Wanlass, and today’s expert, Liz Henderson, for a discussion on one of the key client megatrends, weather. If you enjoyed this episode, don’t forget to subscribe wherever you get your podcasts, and stay tuned for our next conversation featuring industry experts bringing you the latest on topics, including climate risk, workforce wellbeing, ESG trends, and much more. Be sure to check out our show notes and visit our website at Aon dot com to learn more about Aon.

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