Parametric Insurance Begins to Make an Impact
Parametric insurance has made its biggest impact so far with catastrophe bonds covering large-scale risks, such as hurricanes and earthquakes, but the concept is becoming more common in commercial and residential insurance. It’s called parametric because rather than responding to a specific loss, the coverage pays out when an agreed “metric” such as wind speed or ground shaking reaches or exceeds certain intensity. Insurers are offering such coverage based on a wide variety of other metrics, including barometric pressure, rainfall, average snowfall, river water levels, storm surge as measured by tide gauges and even hotel occupancy rates.
Parametric coverage offers a valuable tool in loss management by providing payment within days after a loss to help an organization recover and make repairs while the regular claims process gets underway. In addition, parametric insurance offers, a kind of deductible indemnity to reduce an insured’s increased exposure due to higher percentage deductibles on traditional property coverage. For instance, on windstorm coverage in high-risk coastal areas.
Currently, parametric insurance is becoming more common in property markets as established insurers and startups alike offer parametric-based products for a wide variety of risks. Swiss Re, for instance, has developed parametric products for risks including earthquakes, wildfires (source), the financial impact of high or low river water levels, and for air pollution in Singapore (source). Specialty insurer Sompo has partnered with a German insurer to introduce parametric crop insurance for risks such as drought and heavy frost (source).
New Paradigm Underwriters offers supplemental coverage, based on a wind-speed trigger for named storms that includes business interruption, damage below the traditional insurance deductible, and losses excluded in traditional policies (source). California startup Jumpstart offers an earthquake policy that pays out $10,000 when shaking in a given area reaches a certain intensity (source). A MetLife unit is testing blockchain-based parametric coverage in Singapore for gestational diabetes (source), and AXA has launched parametric insurance for flight delays (source).
The primary requirements for the establishment of a trigger is that the parameter must be independently confirmed, accurately verifiable, and absent of outside influence. For instance, parametric insurance could be used in hurricane- prone areas such Houston to offset direct or indirect losses. In the case of Houston, the parameter could be wind speed. Should the wind speed within a prescribed area or location meet or exceed the predetermined level, the insured would receive an agreed-upon payment under its parametric policy regardless of how much damage their property sustained.
Parametric coverage offers a quick and easy way to obtain insurance and to be paid. Customers can often sign up online, and payment may be made via a blockchain-based smart contract that pays out automatically and electronically when the policy is triggered.
For insurers and investors, parametric coverage offers an easier way to manage risk. Since the contracts are viewed as “short-tail” risks that are paid either during the contract period or not, mitigating risk of lawsuits over claims running on years after the contract has ended. This type of insurance is attractive to capital markets because investors can assess their profits and losses relatively quickly and make decisions on future investments.
BOTTOM LINE
As insurers and startups fine-tune blockchain technology and internet-linked sensors that measure things such as shaking and water levels, expect to see more parametric products developed. Although the coverages can provide payments quickly when a specific event happens and for some clients a parametric trigger policy is a valuable addition to their existing protection, it can be very difficult to recommend at times due to the “miss factor” (narrow definition of trigger) and pricing. As such, traditionally underwritten policies are likely to continue to provide the bulk of coverage for commercial property risks. Retail agents may increasingly be asked to determine how specific parametric coverages may fit into a property program.
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