How Public Entities and Businesses Can Use Parametric for Emergency Funding

How Public Entities and Businesses Can Use Parametric for Emergency Funding
Parametric Insurance

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This insight is part 01 of 05 in this Collection.

Weather

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This insight is part 04 of 12 in this Collection.

October 23, 2024 10 mins

How Public Entities and Businesses Can Use Parametric for Emergency Funding

How Public Entities and Businesses Can Use Parametric for Emergency Funding

As climate change intensifies the frequency and severity of extreme weather events, public entities and businesses need more flexible funding solutions. Parametric stands out as an adaptable resource capable of swiftly responding to potential disasters.

Key Takeaways
  1. Recovery from catastrophes often requires immediate funding, highlighting the importance of liquidity in a robust risk strategy.
  2. The speed of payment and broad coverage of parametric allows businesses and public entities to prioritize recovery over securing urgent funding after a disaster.
  3. Use of parametric insurance can be a key component of a comprehensive and multi-faceted risk management strategy.

The economic impact of a natural disaster often goes far beyond property loss and business interruption. Struggling communities and companies require a fast source of emergency funding for many urgent needs, some which may not be covered by traditional insurance policies.

When Hurricane Idalia struck Florida in August 2023, it caused $3.5 billion in economic losses, of which just $1.5 billion was insured. This $2 billion protection gap highlights why public entities and corporations must reassess their risk management frameworks and ensure they have the most robust resilience strategies in place for catastrophic events.

The protection gap includes the needs of employees and residents who often struggle to manage their own situations, some unable to get to work or buy needed supplies. The dire need is there — funding, however, is often lacking, with options that range from federal assistance to going into debt. 

Parametric insurance, with its flexibility and speed of payment, provides an increasingly viable alternative for public entities and businesses.

“Once you acknowledge that a significant portion of a loss and expense is not covered by traditional insurance, the question is ‘how do you fund for those uncovered losses?’” says Cole Mayer, global head of parametric at Aon. “Do you use cash on hand? Do you take on debt? Or can you transfer some of this risk with an alternative tool such as parametric insurance?  The optimal answer may be a combination of these tools.”

Unlike traditional indemnity insurance, which requires a complex loss adjustment process, parametric insurance delivers capital swiftly based on predefined triggers, such as wind speed or rainfall measurements, within days of the event occurring.

As extreme weather events increase in frequency and severity amid our changing climate, the potential for catastrophic impacts grows. Such “grey swan” events threaten the risk resilience of public entities and corporations that may not be adequately covered by traditional risk management frameworks — thus exposing a protection gap that could jeopardize the recovery of affected communities and businesses in the aftermath.

Addressing Protection Gaps with Parametric

Speed of payment is critical for businesses and organizations that require immediate access to capital following an event. 

  • Parametric is differentiated by its coverage trigger and pre-agreed payouts. Coverage is triggered by the occurrence of an event as determined by neutral third-party data providers, simplifying the claims process.
  • With an independent data trigger and pre-agreed amounts, recoveries occur quickly — as soon as days or weeks after an event. This is critical for businesses that need immediate access to capital following an event. Coverage can be broad, and a wide array of economic exposures arising directly or indirectly from an event can be insured. As a result, traditionally uninsurable exposures become insurable, with the parametric trigger providing the “missing link.”
  • Additionally, parametric insurance can cover a broader range of economic losses, including non-traditional unforeseeable losses, such as non-damage business interruption, loss of attraction and loss of ingress/egress.  
Quote icon

If liquidity is needed, traditional funding options often come with downsides. Parametric provides a number of outstanding reasons why it can be an attractive source of unlevered capital.

Peter Lacovara
Managing Director, Alternative Risk Transfer and Innovation, North America

Where Parametric Sits in the Risk Management Toolbox

Grey swan events — risks that are known, but difficult to quantify — require substantial upfront capital when they occur. Planning for how the immediate costs will be funded is a crucial element of a robust risk management strategy. Consider what sources of liquidity may be available in the event of a catastrophic weather event like a hurricane or earthquake. 

“Parametric is increasingly being used by public entities to help fund many needs post-event,” says Colin Harper, managing director in Aon’s Alternative Risk Transfer and Innovation practice. “However, parametric, with its capacity to free up capital when it’s needed most, is the missing piece of a comprehensive and multi-faceted crisis preparation toolbox for organizational risk managers as well.”

How Businesses and Public Entities are Using Parametric 

To better understand the role of parametric insurance, here are two in-depth loss scenarios to help demonstrate how it complements other liquidity sources: 

 
  • Scenario 1: Public Entity: Earthquake Impacting a Northern California County

    Scenario Description: A significant earthquake in Northern California severely impacts a county.  Following the event, the county government acts immediately to ensure residents are safe and take stock of the various associated expenses.

    Expenses and Exposures:

    • Property damage to the county’s assets (buildings, county infrastructure, etc.)
    • Short-term lost tax revenue/longer-term projected lost property tax revenue 
    • Overtime expense for key emergency personnel 
    • Expense to open aid stations for displaced residents
    • Short- and long-term financial assistance to affected residents
    • Expenses to get critical services back up and running (electricity, water, gas and communications)
    • Ongoing inspections of affected buildings 
    • Increased administrative costs
    • Other unforeseen expenses

    Post-Event Sources of Liquidity Funding:

    • Traditional Insurance: The county has traditional indemnity earthquake insurance, which covers physical damage to the county’s owned assets. After an earthquake, the claims adjustment time can be significant.
      • Cost: Upfront premium (pre-event)
      • Speed: Several months to longer than one year
      • Broadness of Cover: Limited to physical damage at the county’s sites (subject to deductibles, sublimits and exclusions)
    • Federal Emergency Management Agency (FEMA): The county may receive FEMA funds; however, the funds would be limited to certain expenses (typically associated with physical structures/facilities). Funds would also not be received until they are fully documented, reviewed and approved. 
      • Cost: Potential cost share, future “obtain and maintain” requirements
      • Speed: Several months, up to one year or longer
      • Broadness of Cover: Limited to damage at county facilities and associated expenses. There are certain requirements the county must maintain after collecting the funds (e.g., obtain and maintain requirements, etc.)
    • Debt Issuance: The county could choose to issue bonds post-event to help fund the recovery. The cost to do so would be the interest on the issued bonds, which is supported by the underlying revenue streams and credit quality of the county.  The interest rate could be significantly higher than the pre-event rate due to the impacted revenue streams (e.g., tax revenue, etc.). Depending on county statutes, the bond issuance could require a vote from residents.
      • Cost: Interest paid on bonds
      • Speed: Several months, up to one year or longer
      • Broadness of Cover: Depends on the defined scope — proceeds can often only be used for certain predefined costs
    • General/“Rainy Day” Fund: The county could draw down from its general or “rainy day” fund. This would provide quick liquidity post-event but would reduce what is available for other planned projects or unforeseen expenses.
      • Cost: Nil, although there is an “opportunity cost” because the funds cannot be used for other purposes
      • Speed: Generally fast, contingent upon approvals and political processes required to access the funds
      • Broadness of Cover: Generally broad and flexible, although the political processes and compromises required to access the funds could mitigate flexibility
    • Parametric Insurance: The county also has parametric earthquake insurance that pays based on predefined physical parameters (e.g., intensity of shaking) within the county.  The funds are received quickly and can be used for any financial loss associated with the event (with no material exclusions, sublimits, deductibles, etc.) 
      • Cost: Upfront premium (pre-event)
      • Speed: Fast (within days or weeks of the event)
      • Broadness of Cover: Very broad and flexible, can be used for any financial loss resulting from the event (including but not limited to all of the expense categories noted above)  
  • Scenario 2: Business: Hurricane Impacting a South Florida Hotel Operator

    Scenario Description: An intense hurricane impacts South Florida, which immediately results in disruption and expense for this large hotel operator.    

    Expenses and Exposures:

    • Property damage to the hotel and surrounding areas (landscaping, outdoor property, etc.)
    • Short-term business interruption due to wide area damage (loss of attraction, infrastructure damage, etc.)
    • Extensive expense to support employees who are directly and materially impacted
    • Temporary relocation expense for guests
    • Refunds, rebooking fees and other lost guest revenue
    • Long-term loss in revenue due to extensive damage in the area
    • Emergency expense cost (overtime for employees, cost of fuel for generators, etc.)
    • Ongoing inspections of affected buildings 
    • Increased administrative cost to address and compile expenses
    • Other unforeseen expenses

    Post-Event Sources of Liquidity Funding:

    • Traditional Insurance: The hotel operator buys traditional property coverage, which covers physical damage to the hotels and associated business interruption/extra expense. After large events, the claims adjustment time can be significant (upward of one year or longer). While it is a good source of liquidity for physical damage and some business interruption, it will take time to receive the funds and there are also significant deductibles, sublimits and exclusions (resulting in meaningful retentions). 
      • Cost: Upfront premium (pre-event)
      • Speed: Several months, up to one year or longer
      • Broadness of Cover: Limited to physical damage at the hotels themselves (subject to deductibles, sublimits and exclusions) and resulting business interruption
    • Debt Issuance/Credit Revolver: The hotel could choose to issue debt or tap into a credit revolver post-event to help fund the recovery. The cost to do so would be the interest charged on the debt, which is supported by the underlying revenue streams and credit quality of the company.  The interest rate could be significantly higher than the pre-event rate due to the impacted revenue streams.  
      • Cost: Interest paid on debt issued
      • Speed: Generally quick, but could take much longer if there is not an existing credit facility in place
      • Broadness of Cover: Once the funds are secured, they could be used for any purpose
    • Cash On Balance Sheet: The hotel could draw down from its cash on balance sheet. This would provide quick liquidity post-event but would come at a cost (which is the firm’s cost of equity).  
      • Cost: The return on capital required by investors (reflecting the “opportunity cost” associated with the inability to use those funds for other profit-generating purposes)
      • Speed: Generally fast, provided there is sufficient capital on balance sheet
      • Broadness of Cover: Generally broad and flexible
    • Parametric Insurance: The hotel also has parametric hurricane insurance that pays the company based on predefined physical parameters (e.g., intensity of storm in a defined area). The funds are received very quickly and can be used for any financial loss associated with the event (with no material exclusions, sublimits, deductibles, etc.). 
      • Cost: Upfront premium (pre-event)
      • Speed: Very fast (within days or weeks of the event)
      • Broadness of Cover: Very broad and flexible, can be used for any financial loss resulting from the event (including but not limited to all of the expense categories noted above)  

$50M

After Hurricane Laura in 2020, a U.S. energy services firm augmented its property cover with a $50 million limit parametric solution triggered by a named storm tracking within a predefined distance from the facility. The solution covers any economic loss resulting from the triggering event.

Source: Aon Analysis

Learn More
Aon’s Thought Leaders
  • Colin Harper
    Managing Director for Alternative Risk Transfer and Innovation, North America
  • Peter Lacovara
    Managing Director, Alternative Risk Transfer and Innovation, North America
  • Cole Mayer
    Global Head of Parametrics
  • Katie Sabo
    Senior Managing Director, NPG Public Sector, North America

General Disclaimer

This document is not intended to address any specific situation or to provide legal, regulatory, financial, or other advice. While care has been taken in the production of this document, Aon does not warrant, represent or guarantee the accuracy, adequacy, completeness or fitness for any purpose of the document or any part of it and can accept no liability for any loss incurred in any way by any person who may rely on it. Any recipient shall be responsible for the use to which it puts this document. This document has been compiled using information available to us up to its date of publication and is subject to any qualifications made in the document.

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