The Future of Insurance: The Parametric Approach

Parametric insurance is all about parameters. To borrow from CRC Group President Garrett Koehn, it’s “if this, then that” insurance – and it’s about to get big.

How does it work? Koehn gave this example: let’s say you live in Houston, and you have a parametric policy providing $5,000 in benefits should you experience a category 5 hurricane. Let’s say one such hurricane sweeps your area. No underwriter required: you get $5,000, regardless of specifics.

“Payment occurs if the parameters surrounding the event are triggered,” said Denise Johnson at Insurance Journal. “The payment itself is also an agreed-upon figure prior to the event. Thus, there is no need for claims adjustment after the event occurs.”

This type of insurance isn’t new. It was designed in the 90s to help Asian farmers manage weather-related exposures, according to insurtech entrepreneur George Kesselman. Since then, however, it’s become big business, largely thanks to big data. “As data availability and granularity continues to grow exponentially, so do applications of parametric insurance,” Kesselman said.

Slow to set up, fast to pay out

The main challenge in the model is predicting risk – which, again, must be done in advance, and done right, in order to prevent a disparity between the loss and the payout. That’s no simple task. It requires “granular understanding of the loss exposures in play,” said Bethan Moorcraft at Insurance Business Mag.

But if the groundwork is laid meticulously and well, it pays off in terms of “speed, certainty and the ability to plan ahead,” according to a 2018 report by Clyde & Co.

“Whereas traditional indemnity claims can take months or years to solve depending on the loss adjuster assessment and the complexity of the loss, a pay-out when a parametric policy is triggered can be sent within four weeks,” said Moorcraft. “There’s no need for loss adjustment in parametric solutions, as long as the trigger or index is established.”

And the scope is growing

As mentioned, parametric insurance had its start with weather events in farming. But as climate change accelerates, farmers aren’t the only ones facing catastrophic weather events. According to Christopher Flavelle and Katherine Chiglinksy at Carrier Management, “Natural catastrophes cost the insurance industry $80 billion last year, double the average for the past 30 years.” In this landscape, “Parametric policies offer insurers a way to cover risks without the messy complications of sending in a flood of adjusters to assess the damage after a catastrophe.”

This has led to “a growing interest in parametric insurance in the U.S.,” Johnson said. While a parametric policy is designed to fill a gap – not to serve as a standalone – it has the potential to make the aftermath of a storm less of a burden on insurers and policyholders alike.

As for what type of loss event it can help with, “the potential is almost limitless,” said Alex Kaplan of Swiss Re, including “hail, wildfire, river flood, extreme rainfall, snowfall.”

And it’s not just weather. “A commercial client might lose a certain amount of income over a period of time, which could trigger a pay-out without an identified event like a rainstorm or an earthquake occurring,” Moorcraft said. “This will open the possibilities of parametrics to more and more clients.”

In short, we’re on the verge of an emerging trend. The future looks promising for parametric insurance, which can serve as “another tool in your toolbox,” according to Moorcraft, providing you with the ability to “offer a more holistic risk transfer service” to your clients.

As weather events become more common and severe, big data becomes more of a force, and terms and conditions become more restrictive, parametric insurance will continue to gain traction.

In the words of Russ Banham at Carrier Management, insurers “are reimagining parametric insurance for use by a more diverse array of businesses, marking a milestone in the product’s historical development.”

Is your policy administration system ready for the future of insurance? If you have any doubts, request a Silvervine Software demo.