Puerto Rico’s Innovative Use of Parametric Insurance
By Katie Sabo, Aon, National Public Sector Practice
Puerto Rico is no stranger to the devastating effects of natural disasters. Hurricanes and earthquakes are a consistent threat to the island. These disasters have left behind a trail of destruction but also an opportunity to think about new, innovative ideas for resiliency. To better protect itself and ensure a faster recovery, Puerto Rico, in partnership with FEMA, has taken a bold step by securing a parametric insurance policy as another tool in the toolbox to support pre- and post-disaster hurricane and earthquake recovery efforts. This innovative approach not only provides financial protection but also helps the Commonwealth reduce FEMA requirements that recipients of disaster aid maintain insurance to be eligible for future disaster assistance.
What is Parametric Insurance?
Unlike traditional insurance that requires a lengthy claims process to assess damages, parametric insurance offers a more streamlined and rapid payout mechanism. It works by identifying a pre-determined insurance payout based on the occurrence of a specific event; in the case of Puerto Rico, hurricanes or earthquakes exceeding a certain threshold of severity (e.g., wind speed or earthquake magnitude). This eliminates the need for lengthy damage assessments and ensures quick access to funds for immediate recovery efforts.
Puerto Rico's Parametric Policy
Aon's parametric insurance program provides Puerto Rico with significant financial protection against hurricanes and earthquakes. This groundbreaking program is the largest government-sponsored parametric transaction for the island. An important innovation of this parametric product is that it marks the first time such a mechanism has been used to reduce FEMA's insurance requirements that disaster aid recipients “obtain and maintain” insurance.
FEMA's Obtain & Maintain (O&M) Requirements
FEMA's provides post-disaster assistance to governments through its Public Assistance program. O&M requirements mandate that Public Assistance applicants who have received funds for facilities for disaster recovery, for future disasters, obtain and maintain insurance coverage going forward. This ensures that these structures remain insured against future risks and reduces the financial burden on taxpayers in the event of another disaster.
How Parametric Insurance Helps
Until now, FEMA’s requirements had to be met with traditional property insurance. The use of this parametric policy, however, provides broad financial protection to Puerto Rico and FEMA has allowed this to satisfy its insurance requirements. By securing parametric insurance, Puerto Rico demonstrates its commitment to reducing FEMA's O&M requirements and proactively managing its disaster risk. The quick payout mechanism of parametric insurance allows the island to access funds rapidly after a catastrophe, facilitating timely repairs and reconstruction efforts. This not only reduces the financial impact on the island but also minimizes disruption to essential services and accelerates the overall recovery process.
Benefits for Puerto Rico
Rapid Payouts: Access to immediate funds for post-disaster recovery.
Reduced Risk: Mitigates the financial impact of hurricanes and earthquakes.
FEMA Compliance: Helps reduce Puerto Rico’s O&M requirements.
Enhanced Resilience: Strengthens the island's ability to bounce back from hurricanes and earthquakes.
What FEMA Doesn't Cover
While FEMA plays a vital role in disaster recovery, they do not cover everything and governments cannot rely on them for all their post-disaster economic needs. Public assistance has limitations, leaving potential funding gaps that can strain budgets and taxpayer, for instance:
Deductibles and Cost Share: FEMA assistance often comes with deductibles and cost-sharing requirements that are the responsibility of the applicant.
Indirect Costs: The hidden costs of a disaster – like lost revenue and increased operating expenses – are often ineligible for FEMA reimbursement.
Ineligible Infrastructure: Certain infrastructure, like parks and recreational facilities, may not qualify for FEMA public assistance, leaving the financial burden on taxpayers.
Parametric insurance could be well suited to covering these needs. There are current conversations underway on expanding FEMA approval for utilization of parametric insurance for the post-disaster costs FEMA doesn’t cover, and for which parametric insurance can play a critical, timely and material role in supporting pre-and post-disaster for public entities.
Insurance has a unique role in the public sector space to be a catalyst for resiliency both pre-and post-disaster. Puerto Rico's early adoption of parametric insurance is a significant step towards building a more resilient future. By embracing innovative solutions and proactively managing disaster risk, the island sets an example for other public entities facing similar challenges.
Contact: Katie Sabo, katie.sabo@aon.com | Aon, National Public Sector Practice
