In the last three years there have been record-breaking extreme weather events, changing seasonality, increases in temperature and rainfall and overall greater volatility globally. This specifically has created a challenge for the U.S. construction industry, which after a slight decline in construction spending in 2017 is expected to have six percent growth in 2018 and will to continue to grow through 2021. The recent increase in construction spending and expected projects to come has allowed the insurance and wider financial services sector to offer increasingly tailored solutions that allow both owners and operators of construction projects to manage the financial impact of adverse weather on revenues and costs.

In a sense “weather insurance” has always existed, in that one of the main reasons for insurance to come into existence was to mitigate the risks associated with shipping in 17th century, of which weather was seen as a primary risk, and it is a fact that the direct physical/material damage to construction projects from events, such as hurricanes and floods, can be covered by property damage policies.

However, there is typically no financial recovery for the wider area impact of such events on these projects. Consider the impact of rainfall on concrete pouring or frigid temperatures on workers’ safety. Not only can this cause a delay in the work itself, due to the removal of water or additional personnel breaks, but can cause further issues as to the quality of work performed, none of which would be protected in a traditional policy. Traditional property damage policies also do not address the impact of season to season variations in temperature, rainfall or snow that can impact a portfolio of construction projects, yet this cost is often far greater than the cost of reinstating a building following flood or wind damage. Weather is frequently blamed (call it a force majeure), but who takes the weather risk or is responsible for the delay in completion? Sometimes a judge has to answer that question. Fortunately, the weather market is there to smooth this volatility and cover these extra costs, expediting expenses or liquidated damages in a more cost-effective way than holding this on a project’s balance sheet.

These risks were all evident by contractors working in Los Angeles over the past year who faced extremes of heat and drought that caused widespread damage from wildfires, followed by extreme rainfalls that caused losses from flooding. Similarly, in the Midwest, heavy winter snowfall and extreme temperatures meant fewer working man hours and additional costs associated with gritting and servicing roads. Although weather in the physical sense cannot be controlled, parametric solutions provide an efficient mechanism for the financial impact of weather uncertainty to be qualified, quantified and mitigated.

How does parametric Insurance work?

Here's how weather insurance works:

• Weather Consulting. Historical weather data is applied to details of a construction project including schedule, budget and means and methods to understand how critical path may be impacted by adverse weather;
• Program Structure and Brokerage. The insurer creates a bespoke program based on project exposures and schedule to mitigate weather risk on a project;
• Weather Risk Transferred to Third Party. Outside capital provides Weather Insurance coverage on a parametric basis, meaning clients do not have to prove the loss, as the claim is paid on an agreed value when a pre-agreed weather trigger is reached and captured by the weather data.

Parametric solutions respond to movements in an agreed weather-denominated index or the occurrence of a pre-defined event – usually a natural catastrophe – of a pre-specified magnitude during the policy period. No proof of physical loss or damage is required to trigger a policy, simply the occurrence of the covered event or a movement in the reference index above or below a pre-agreed threshold. The claim value is calculated according to a pre-agreed formula applied to the value of the index, and claims payments are made quickly once the policy has been triggered and the value of the index is confirmed. The reference index is typically constructed from weather data – temperature, rainfall, sunshine, snow or wind, for etc. – and these parameters can be included individually or in combination.

Each policy is tailored to the precise exposures of the risk protection buyer, ensuring that it covers the weather scenarios that can negatively impact the business. These will vary according to the location and period of concern, the business sector in which the risk protection buyer operates and the motivation for buying protection. For example, a contractor worried about excessive rain during a construction project could purchase a policy that triggers if rainfall exceeds a pre-agreed number of millimeters during the project. There could be a single, one-off payment if the index threshold is exceeded, or alternatively the payout could increase per additional measurement (millimeter, degree, etc.) once the initial index threshold is breached.

Parametric Insurance vs. Traditional Indemnity

The main differences between traditional and parametric insurance are underlined by how the solutions respond to a loss related event. With traditional insurance the policies look to indemnify the insured and reinstate coverage benefits, which requires a loss adjustment for claims to be paid. This process inevitably takes time and can lead to delays. In contrast, parametric solutions respond to clearly defined triggers identified prior to policy instatement.

This allows the insured to clearly understand exactly how and when a policy will respond, resulting in few disputes or differing interpretations of the cover or claim. Ultimately, this mean that claims are typically paid quickly and in an amount that is expected by the insured.