What is parametric insurance?

October 30, 2023 6:30 AM

Palm trees seen through drops of rain during a storm. Photographer: Eric Thayer/Bloomberg — Palm trees seen through drops of rain during a storm.

Parametric insurance isn't new but with an increasing number of global catastrophes more insurers and consumers are looking for policies that can provide immediate disaster response.

Aon, a global professional services firm, released its Q3 Global Catastrophe Recap report, which analyzes natural hazard activity worldwide. The report reveals that global insured losses from natural disaster events reached $88 billion by the end of Q3, driven by U.S. and Italian severe convective storms, and the Maui wildfire – one of the deadliest and costliest wildfires in U.S. history. The aggregated death toll from 2023 natural catastrophe events had breached 75,000 during the same period, making 2023 the deadliest year since 2010.

Digital Insurance reached out to several insurance professionals to gain insight into what parametric insurance is, when it's triggered and how access to data plays a role.

Valerie Turpin, chief underwriting officer, property at Arch Insurance

"The first time I heard about parametric insurance was back in 1999 or 2000. Ski resorts wanted to have coverage for loss of income if there wasn't enough snow for the resort to operate. The challenge was that there wasn't enough data to confidently underwrite any risk for certain types of catastrophes," Turpin said. "Since then, the development of modeling and increased access to data has led to more availability, so we're seeing parametric insurance become a more viable product."

Valerie Turpin-Arch Insurance.jpg — Valerie Turpin

Turpin added: "Typically, the trigger is a catastrophic event that can be measured on an impartial basis by a third-party. What is critical is that the trigger of payment for an economic loss be measured by a pre-agreed upon set of criteria. Using the ski resort example, if there is no snow, nobody goes to a ski resort. So there will be a definition in the contract about how the snow will be measured, and what is the minimum amount of snow.

"Insureds are looking to get more protection if they can afford to pay for it. That being said, it's expensive. If you are a CFO, and you need to explain to your board of directors that the indemnity will not be based on the actual loss sustained. This requires a certain risk appetite and an understanding of the potential disconnect between a loss and the benefits of such policy. Smaller companies often inquire about parametric products, but they find that it is difficult for them to sell the concept internally. Additionally, the amount of data that you must provide to obtain an offer is very extensive and requires support from brokers with advanced analytics tools. Therefore, you need to have a certain level of risk management sophistication within your company to be able to even pursue an offer."

Turpin said: "It's my opinion that we have made strides around access to data and the capacity of insurance companies to transform, aggregate and enrich data. For this reason, I can see some companies creating products to make parametric insurance more accessible."

Dianna Nelson, structurer, North America, Swiss Re

"It's an effective and efficient supplement to traditional insurance. I like to define it by comparing traditional to parametric. In a nutshell, I would describe traditional insurance as requiring, among other things, direct physical damage for a claim. With parametric, we only care about how fast the wind blows or how hard the ground shakes," Nelson said.

"Depending on the peril, we always like to use a third-party data provider that is not affiliated with us or the insured. For example, our hurricane parametric coverage uses Moody's RMS HWind, they use satellite information, buoy observations, [and] anemometer observations after the event has occurred and then they're able to interpolate those wind speeds on a footprint. They would give us a footprint after the event and we would use that to determine the location and what the wind speed was and if it meets a pre-defined trigger."

"There's more awareness of parametric coverage amongst different clients and brokers than maybe there was five or 10 years ago. … We view parametric as more of a supplement type coverage to traditional insurance, which definitely still plays a main role. … I do think the interest is going to continue to grow but I don't necessarily see any near term softening of the market."

Sid Mouncey, CEO, Blink Parametric

"The demand for parametric solutions is increasing rapidly driven by evolving risk, increasing mainstream insurance carrier adoption and exciting technology advancement, coupled with the proliferation of smart phone technology within the consumer space," Mouncey said in an emailed response.

"Internet of Things (IoT) devices that create connected homes with the use of smart devices, smart meters and digital assistants provide huge amounts of data that can inform a multitude of solution-based parametric insurance services. For example, if an insured IOT-supported domestic appliance becomes faulty, automatic fault code alerts can be issued to the insurance carrier or service provider, triggering corrective action options such as service calls or immediate cash payout to the appliance owner's bank account. I've heard it best described that parametric insurance is 'at the tip of the IoT iceberg.'"

Sarah Kim partner at Centana Growth Partners

"In traditional insurance, you pay out based on the value of a loss that's incurred, and parametric insurance pays out on a predetermined amount based on a trigger event. Think of it as an agreed value contract, you say, if X happens, we will pay you Y. And the question is, can you get a signal or a trigger event that everyone can agree on, that really represents the risk that the insured wants, and so you need to get as close to that risk and reality on the ground."

Sarah Kim

"The trigger event could be something like a hurricane surpassing a specific category, business interruption due to cyber attacks, or the strength of an earthquake. We're seeing a lot of new opportunities using sensors, IoT, to really help understand those trigger events. And some of the complexities we've seen in the market is when you try to do parametric insurance without being able to replicate that true loss, but what's nice about it is you can settle immediately, really quickly get that cash back into the insured hands and get them back into the market and back on their feet. Parametric insurance can provide a unique capability in the market that augments the traditional insurance markets," Kim said.

"I think when you're really thinking about complex risks, like climate change, you need to have all the toolkits in your toolbox. You can have a traditional insurance tower, you can issue cat bonds, you can use parametric, and when you combine these together, you can actually create a more robust risk management process for your company," Kim added.

Siddartha Jha, founder and CEO of Arbol

Siddartha Jha

"The foundation of parametric insurance lies in its predefined triggers, which are based on measurable and verifiable parameters," Jha wrote in an emailed response. "For instance, a hurricane policy might use wind speed or barometric pressure as triggers, while an agricultural policy could depend on rainfall levels or temperature measurements. These parameters are sourced from reliable and unbiased data sources, including satellite data, weather stations, and seismic monitoring networks. The objectivity of these data sources ensures a transparent and fair process, where both insurers and insured have clarity on the conditions for payout."

"The backbone of parametric insurance is the sophisticated technology and data collection methods that enable real-time analysis and validation of triggers,"Jha said. "Weather satellites provide comprehensive atmospheric data, sensors and IoT devices offer granular, location-specific information, and historical data contributes to understanding patterns and setting accurate triggers. Advanced algorithms and analytics are employed to sift through this wealth of data in real-time, ensuring that payouts are triggered accurately and without delay."

Tom Markovic, global head of Marsh’s Parametric Center of Excellence

"Parametric solutions are typically used to supplement your existing insurance portfolio, filling any coverage gaps that can leave your company vulnerable. These underinsured or uninsurable risks include indirect financial loss, deductibles or exclusions, and non-damage business interruption. Quick payouts can enhance your company's liquidity, reduce revenue volatility, and enable investment in post-loss priorities, such as aiding affected employees," Markovic said in a report from Marsh.