As more frequent man-made and natural climate disasters disrupt global markets and give rise to steep economic losses, demand has grown for flexible, alternative insurance products that can address protection gaps – especially in areas of complex or infrequent risk. Parametric insurance, while not entirely new, has been gaining relevance in the wake of Covid-19 and other catastrophic climate events. From reinsurance to a variety of small scale micro-insurance offerings, parametric contracts are increasingly being used to deliver flexible, data-based, real-time covers in hard-to-insure, niche markets.
What is parametric insurance?
Parametric insurance differs from traditional insurance in that it is not claims-driven, with payouts made to customers after a loss. Instead, parametric insurance uses triggers or indexes (not claims) to payout after a specific event has occurred. Policyholders, therefore, are insured against a specific event with payments based on a predefined parameter, rather than the amount of a specific claim or loss. Parametric triggers could be applied to a range of loss types, from hotel occupancy rates to flight delays to the depth of a flood. Generally, a parametric contract includes the client, a specific parameter or index (the trigger), the contract or output (a payment amount), a third party or analytical agent responsible for verifying the trigger (i.e. a government agency) and the capital provider.
The growing parametric opportunity
In recent years, Insurtech entrants have helped incumbents recognize the need for innovation and flexibility when it comes to underwriting risk and creating new product solutions (see Stable and The Demex Group as two such examples). Parametric insurance, which is powered by sophisticated analytics, new data sets and innovative technologies, similarly provides an opportunity for incumbents looking to supplement and evolve their approach to loss prevention/mitigation and disaster financing.
Not simply a replacement of conventional insurance for uninsurable categories, parametric covers are structured to help speed recovery and minimize business interruptions, particularly in the wake of a catastrophe. Recognized as an enormous opportunity by reinsurers for years, incumbents are seeing fresh opportunities emerging for more flexible, novel protections that can handle the speed necessary for underwriting unusual risk types. Parametric contracts solve a multitude of problems for insurers by:
- Protecting against economic losses and increasing risk awareness by sourcing additional capacity and providing liquidity through pre-defined payouts
- Helping develop embedded insurance products and micro-offerings in areas where traditional individual coverage is extremely limited or non-existent (for example, flight delay insurance)
- Eliminating the issue of pricing risk based on customer assets (when products are priced too high for the market, no one purchases – i.e. traditional flood insurance in certain high-risk markets)
- Aiding recovery by speeding payments to policyholders after a major disaster, as claims-based conventional insurance is both costly, slow moving, and usually includes a high deductible
While parametric insurance is often seen as a tool for climate change resiliency, linked to both catastrophic and non-catastrophic weather risk, it is also a kind of proof of concept for how to weave innovative technologies into the very fabric of the insurance industry. As more and more parametric applications are explored, there will be a wellspring of opportunity for incumbents who can identify the best use cases and put the power of the parametrics to work for their business and customers alike.