How parametric insurance can smooth income volatility for retailers
There are many external risks that retailers can do little about; risks that can have a big impact on the bottom line. Take extreme weather. Unseasonably cold, hot or wet weather has the potential to significantly reduce consumer footfall in stores as well as reducing demands for seasonal stock. If it’s not the weather, it could be a terrorist event or incident like the Salisbury nerve agent attack that reduces the number of shoppers in an area. What if a major transport hub like Heathrow closes at a critical sales period, or a sea port is hit by a strike threatening the ‘just in time’ delivery of a seasonally sensitive product?
To try and smooth this volatility, retailers are increasingly taking advantage of parametric insurance solutions that can cover financial losses related to external events not covered by traditional insurance – or what the insurance industry calls non-damage business interruption (NDBI). Advances in data science means there is now enough information for insurers to offer financial cover for those external risks that, despite the best in risk control, a retailer can do little about.
Rain stops play
Last November, John Lewis blamed unseasonably mild weather for an 8%1 decline in sales, while earlier in the year clothing retailer H&M attributed a slump in profits in the first quarter of 20182 to cold weather hitting the sales of their spring clothing range. The long hot summer of 2018 – while a boom for food and drink sales – led to a decline in demand at clothing and non-food stores as consumers chose to enjoy the good weather on the beach or in the garden as opposed to sweating it out on the high street. Even England’s run of success in the football World Cup had the knock-on effect of damaging clothing sales (Gareth Southgate waistcoats being the notable exception). Storm Deirdre, which hit the UK on one of the most important pre-Christmas shopping days, is also blamed by retail analysts Springboard to have impacted footfall by 9%3 compared to the corresponding Saturday in 2017.
With climate change appearing to influence the UK’s weather, creating more extreme events from flooding to long hot dry summers, it’s likely that the weather will feature ever more prominently as a factor in retailers’ earnings announcements. But other factors have also served to damage sales. When singer Olly Murs tweeted there was a possible terrorist incident event during Black Friday shopping in Oxford Street in 2017, the resulting chaos and police lockdown is said to have cost retailers millions in lost sales. And, in the months after the Salisbury nerve agent attack, many businesses reported footfall down by as much as 80%4.
Pulling the parametric trigger
In the past, retailers have been at the mercy of ‘black swan events’ like these but the availability of high quality data when it comes to understanding and quantifying the impact on retailers of extreme weather or a terrorist incident, has led to the development of a new range of parametric insurance products. Parametric insurance pays out based on a pre-determined trigger point being met such as a specified weather temperature, level of snowfall, or a non-weather related event that could directly impact footfall and, as a consequence, a retailer’s sales.
Similar weather derivative products have been a feature of the energy and agricultural industries for more than 20 years, but it’s only recently that these types of policies have been offered more widely. A retailer now has the opportunity to insure against the impact of good or bad weather on its sales, or a terrorist incident nearby affecting footfall. In turn, by transferring the risk to an insurer’s balance sheet, it can smooth its income and protect itself against any unforeseen losses.
There is no long, drawn out claims process either with claims paid quickly as soon as the conditions of a policy have been met such as with a particular level of rainfall for example, or drop in footfall. Parametric insurance differs from indemnity insurance in that once the client has suffered and reported a loss following a pre-agreed trigger event – for example, there has been a verified level of rainfall or a decrease in footfall over a specified time period – then the policy will pay out.
As many retailers grow their intangible assets, insurance is having to respond with new products that move away from simply covering a shop building that’s been flooded or burnt down. Parametric insurance meets that coverage gap and can apply equally to a retailer with a strong physical presence, pure online presence, or both. Additionally, as the parameters of each policy can be flexed to suit each retailer, the pricing of these policies can also be very competitive, particularly given the level of confidence they provide for retailers when it comes to managing their earnings volatility.
Only a few years ago, cyber insurance was seen as a ‘nice to have’ but not the essential purchase that it has become today. In the same way, we expect to see parametric insurance take up a growing place in every retailer’s risk management programme as businesses look beyond traditional risks and use insurance to help them bring more certainty to their business.
Dan Fox, UK Retail Practice Leader, Aon
Paul Ramiz, Director for Innovation and Solutions, Aon
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This article has been compiled using information available to us up to 14.01.19. Aon is authorised and regulated by the Financial Conduct Authority.