Why AI data centers fuel demand for parametric insurance

• Key insight: Insurers are developing solutions tailored to data center needs
• Forward look: Parametric coverage is developing quickly

Demand will soon intensify for parametric insurance covering data centers built to serve AI, according to experts at commercial insurers specializing in this relatively new product.

Parametric insurance pays out when a loss event happens and is priced based on the event's probability, as compared to conventional insurance which covers the actual value of the loss. This type of insurance appeals to the major tech firms as a way to cover the AI data centers they build.

"The market has come together to develop solutions," said James Nelson, leader of the U.S. data centers and digital infrastructure practice at Lockton Companies, a global insurance brokerage, in a recent webcast. "Insurance is maybe not always the fastest market to adapt to new development, but in this case, everybody is moving very, very quickly."

Parametric coverage for data centers focuses mainly on natural catastrophe events and issues with the service-level agreements (SLAs) between center owners and their tenants. Large tech companies building or backing the data centers, including Microsoft, Amazon and Google, are experts at managing the centers and minimizing operational risks, according to Sharon Haran, chief commercial officer of Parametrix Solutions, which offers parametric coverage for digital infrastructure.

While natural catastrophes would greatly affect the infrastructure supporting data centers, the likelihood of such an event hitting a data center is low enough to be an acceptable risk for insurers, Haran said. 

"We don't see here a frequency of 10 or 20% a year, which would make the product extremely expensive and not profitable from the insurance point of view," he said. "But we see a frequency that makes sense for both the insured and the insurer."

As physical assets, data centers are well-engineered and well-built, said Nelson. "There hasn't been a billion dollar-plus loss out there that stress tests the insurance market, stress tests all the interconnectivity of the contracts," he said.

SLAs are the biggest risk for data centers, which parametric insurance can address, according to Haran. For data centers, SLAs define the owner's performance obligations to tenants for elements such as power supply, temperature levels and internet connectivity. Each of these is measurable and quantifiable in relation to parameters set in a SLA, which are the benchmarks for parametric insurance coverage, Haran said.

SLAs often set percentages of rent that tenants can withhold or get back if criteria in the agreement are not met, which amount to losses that the owner could use parametric insurance to recoup. An owner losing rent income will have issues serving their debts and paying salaries. 

"That instability, fluctuation or potential fluctuation in the cash flow of the organization are exactly the point where SLA insurance tries to bring certainty to the operators, investors and lenders," Haran said.

Parametric insurance for data centers is a relatively new product that began about two years ago, according to Nelson. However, lenders financing data construction are requiring insurance coverage, which is driving growth for parametric coverage, he added.

The product is catching on, although it will not be the only option for data center insurance, according to Martin Hotz, head of parametric nat cat at Swiss Re Corporate Solutions. 

"It will play a piece-of-a-puzzle type role," Hotz said. "The trend is friendly, but it's a lot in the pipeline. The picture will be very different looking in three to five years."