Traditional insurance plans may be leaving construction contractors vulnerable when it comes to unexpected project delays or expenses. Parametric insurance may be able to help close the gap, protect margins and hedge against risks.

When projects experience delays, unexpected costs or losses, contractors’ margins suffer. If the funds to cover these unforeseen expenses are not available, the affected project may be at risk for failure. Furthermore, if surety capacity is stretched, delays and losses can create real challenges for a project.

Traditional solutions for losses and emergency funds may fall short of what contractors need to effectively respond when an adverse event affects a large project or multiple projects simultaneously. Recently, the insurance market has seen growth in an alternative hedge against adverse events—parametric insurance.

Parametric insurance: What it is and how can it help?

Parametric insurance is a policy that is triggered by an event instead of by physical damage. Coverage is arranged for a specific modeled event (trigger definition), that is measurable by a neutral third party. If an event meets the trigger definition, the claim is paid—and there is no financial deductible, no loss adjuster and no exclusions.

Where traditional risk solutions may fall short

Guaranteed maximum price and fixed price construction projects have financial risks that are not insured under traditional insurance policies. These may be risks that are “business risks” or “stranded risks” that are outside the control of even the most conservative project managers. Examples of these risks, which can affect multiple projects at once, include:

• project disruption due to a natural disaster, such as an earthquake, flood, wildfire or hurricane;
• fluctuating cost of construction inputs, which can include labor, equipment, materials’ availability and pricing;
• inaccessible job sites because of weather or acts of God;
• reduced productivity due to extreme heat or cold; and
• skilled labor shortages.

Why now? An increased need and fewer available resources

The need to cover these unforeseen or uncontrollable factors is on the rise. In recent years, project input costs have increased dramatically, labor shortages and natural catastrophes such as floods and wildfires have delayed projects, and “pop-up” tariffs have caused financial problems for projects without causing actual damage to the project.

Further complicating matters, resources to mitigate unforeseen events have been historically limited and they don’t guard against all current vulnerabilities.

Delays or dramatic cost increases

Cash reserves and lines of credit are sources for emergency funds; the surety is a last resort. These may not be ideal, or even possible, solutions for contractors who dedicate their liquid assets to existing projects or mobilization.

Traditional insurance policies pay claims for physical damage, third-party property damage and bodily injury, including delays that result from property damage, but there has not always been a way to mitigate the risks associated with “bad luck” that doesn’t physically harm anyone or damage the physical structure. These claims can drag out for months or years, which doesn’t address immediate finance requirements.

Now, the construction industry has another tool in its (proverbial) tool belt to transform the risk transfer options available to them—to offer another line of insurance coverage for the uninsurable financial losses of catastrophic events.

Parametric insurance demystified

The concept is straight forward and simple. Parametric insurance is a product that pays a pre-agreed sum when a measurable event occurs (upon notice from the insured and verification with the agreed third party). There is no loss adjuster, no legal battles, no haggling, no investigation, no fraud, no exclusions. The process is uncomplicated, predictable and most importantly, certain.

Property doesn’t even have to be damaged. Parametric products are intended to provide a financial solution for firms who require immediate liquidity if an adverse event affects a large project or multiple projects. Parametric insurance could be part of a larger strategy to protect lines of credit and surety capacity on projects that may be stretched thin. Alternatively, parametric insurance may also play a role in providing a financial solution to underinsured risks such as wildfires or extra expenses tied to catastrophic weather or earthquake events.

Examples of Parametric Coverage

Examples of parametric coverage include:

• The ambient air temperature drops below a certain level which interrupts the cement mixing and curing process. This requires additional inputs to perform the project. A parametric product could pay a claim for a given lump sum should the temperature hit an agreed threshold with the National Weather Service at an agreed location.
• There is an earthquake in a given zip code that is outlined in the coverage and it registers at or above the predetermined magnitude . The insurance company pays the insured a pre-agreed sum.
• High winds blow through Central Florida temporarily stopping a project. The parametric insurance could help deliver financial resources to absorb delay penalties if the wind speed reached an agreed level.
• An owner or contractor has a concentration of projects in a high-hazard geographic region, such as an area prone to floods or earthquakes. Parametric insurance coverage can help absorb delay penalties and arrange alternative suppliers or strategies should a large event occur and agreed upon thresholds were met.

What contractors need to know

Parametric insurance is not intended to replace traditional insurance plans. Rather, it provides an important, additional layer of protection in the face of adverse events. It may not replace an existing insurance and risk management strategy, but it is a viable tool to be used in analyzing risk and transferring risk where it makes sense .

Builder’s risk (all risk), property all risk, worker’s compensation, professional liability or general liability insurance are still essential components of insurance platform/policy/protocol.

It is simple, straight-forward and certain. Parametric insurance endeavors to eliminate the gray areas when measurable events occur. If an adverse event has happened and it has met the agreed upon measures, then payment is certain.

Parametric insurance is tied to specific triggers, not a host of events. Parametric insurance products are not tied to the actual value of a loss sustained. Instead, the buyer and insurer agree to an independent sum to be paid should an agreed upon event occur.

One size does not fit all. Parametric markets are working with firms to build products that respond to the unique risks of a project. Risks that were not seen as insurable in the past may now, to a certain extent, be transferable. Markets may offer limits of insurance ranging from $5 million into the hundreds of millions of dollars for events that are measurable parametric events.

Is it right for the firm?

An effective construction broker will have the resources to help identify important risks not covered by traditional insurance, find parametric solutions and help the firm evaluate the costs and benefits of using parametric insurance products to transfer risks.