Insurance is one of the few industries that have remained largely unchanged over the past few decades at a low level: You suffer losses as a direct result of something going south, and you get paid by your insurer.
But that old model doesn’t always work. For example, a construction company in a region regularly ravaged by hurricanes may see its projects weather these storms largely unscathed, but it may still be at a loss in terms of time and other potential costs because crews simply couldn’t get to work.
Your traditional indemnity policy might pay this company based on the size of its losses, but it doesn’t have to pay for those unforeseen follow-up costs because it isn’t “damage” in the usual sense. You could say that the company is getting the short end of the stick here.
Parametric insurance, on the other hand, ensures that everyone can win. Instead of insuring customers based on the size of losses incurred, parametric contracts insure customers against the size of events. So in our example, the construction company can see a payout if there is a certain “trigger event”, such as the area affected by a Category 4 or higher hurricane, or if the wind speed reaches a certain pre-specified limit.
Parametric insurance (as opposed to traditional non-life insurance) is a type of insurance that pre-specifies the amount of the payout based on concrete “trigger” events. For example, the payout can be tied to a particular weather event, such as the height of a river above its flood point.
This type of insurance is also known as index insurance because it relies on data and automation, a combination that explains why this approach enjoys tailwinds. Instead of submitting and reviewing claims, both parties can rely on information proving that a trigger event has occurred.
Using data in this way makes the process more efficient for both the insurer and the insured. “The main advantages of parametric insurance are fast payouts, high flexibility and the ability to cover losses that are difficult to model,” said Mayer.
The quick payouts this model allows make it particularly useful for weather-related insurance, where those affected benefit most from quick access to funds. This is evident in the number of insurtech startups building parametric solutions for this space.