Reinsurance broker Guy Carpenter has conceptualised and designed a parametric risk transfer solution that looks to mitigate losses to building structures as a result of large, ash fall-producing volcanic eruptions.
In a recent article, Catastrophe Risk Analyst at Guy Carpenter, Delioma Oramas Dorta and Guillermo Franco, Managing Director & Global Head of Catastrophe Risk Research, Guy Carpenter, discuss the potential for parametric risk transfer solutions, such as catastrophe bonds, to offset the impacts of volcanic eruptions.
As shown by our sister publication Artemis’ extensive Deal Directory, parametric risk transfer solutions are commonplace in the catastrophe bond market, a sub-sector of the insurance-linked securities (ILS) space.
Typically, parametric risk transfer solutions offer protection against earthquake risks, but Guy Carpenter states that with more advanced fully probabilistic volcano risk models, parametric solutions could be designed to protect against volcanic eruptions in Japan, and elsewhere around the world.
Specialist teams at the reinsurance broker have collaborated and subsequently proposed a parametric solution, designed on the basis of Guy Carpenter’s fully probabilistic loss model for explosive volcanic eruptions from six Japanese volcanoes, including Mt. Fuji.
“This volcano model estimates losses arising from the deposition of volcanic ash fall on building structures and considers residential, commercial and industrial lines.
“Such an instrument could be interesting to stakeholders such as insurers with large earthquake concentrations in the area (earthquake policies cover volcano risk in Japan) or regional governments interested in ceding losses to dwellings from a severe eruption impacting the area, among others.
“This type of parametric solution could be applied to other regions in the world at risk of explosive volcanic eruptions, as long as certain conditions are in place, such as the availability of a fully probabilistic volcanic eruption catastrophe loss model,” explain the pair.
Demand for this type of solution does appear to be on the rise, underlined by the ambitions of the Red Cross to issue the industry’s first pure volcano risk parametric catastrophe bond, with progress reportedly being made.
According to Guy Carpenter, one of the hindrances to the development of parametric solutions for volcanic eruption is around risk modelling, which, when compared with earthquake risk and hurricane risk, is lacking.
Parametric risk transfer solutions are structured to payout when predetermined triggers are met, such as the magnitude of an earthquake or the strength of a storm, but in order for any parameters to be set, adequate modelling and subsequent understanding of the risk is essential.
“After researching several physical parameters associated with the phenomenon of volcanic ash fall, we propose a combination of two eruption-related parameters on the basis of which trigger threshold levels are defined: height of the eruptive column and predominant direction of movement of the eruptive plume.
“Both parameters are explicitly defined for each of the volcano ash fall events featured in Guy Carpenter’s volcano risk model,” state Dorta and Franco.
Furthermore, the design of parametric risk transfer solutions require that the selected parameters are reported on a near-real time basis, which needs to come from a reliable and trusted source.
“In summary, the design of this parametric product relies on easily obtainable, observable physical parameters relating to explosive volcanic eruptions, which makes this prototype potentially applicable to many other volcanic settings worldwide without the need for any special monitoring equipment,” the pair explained.