Parametric Insurance: The Future of Swift and Precise Disaster Recovery?

In the wake of Hurricane Beryl’s devastating impact on the islands of Grenada, St. Vincent, and the Grenadines, the importance of parametric insurance – and its rising popularity in the NatCat space, is becoming increasingly evident. 

Parametric insurance, unlike traditional indemnity insurance, pays out based on the severity of the event rather than the extent of the damage. This rapid response mechanism is set to provide much-needed funds to the affected islands, aiding in their swift recovery.

With the increasing regularity of extreme weather events occurring, (hurricanes, typhoons, and tropical cyclones are essentially the same weather phenomenon – namely large tropical storm systems that revolve around an area of low pressure and produce heavy rain and wind speeds exceeding 74 mph (119 kph) the insurance industry is under increasing pressure to find a solution that both serves customers speedily in dire situations of loss, without incurring huge losses themselves.

Parametric offerings seem to provide a clearcut solution to what has traditionally been an area mired in drawn out claims processing, heavy losses and also incidents of fraud.

In a recent poll run by Insurtech Insights asking our insurance community what the biggest benefits parametric solutions offer, votes were fairly evenly split. 31% of respondents cited that ‘providing insurance solutions to previously uninsurable areas was the biggest benefit. A further 28%, 22% and 19% respectively considered predictability/transparency, speed of payout and streamlined claims processing as critical factors.

Daniel Andrews, Insurance Director at Vitesse succinctly sums up the situation, saying: “Parametric insurance is gaining popularity due to its certainty regarding claim payment triggers, amounts, and timelines. Additionally, advancements in data collection and processing have significantly broadened the types of risks that parametric policies can cover, from home floods to earthquake damage, and intangible risks such as loss of attraction or downtime following a cyber-attack.”

As our climate continues to throw us curve balls and NatCat events continue to tax the traditional insurance industry, we talk to three leading experts about the rising popularity of parametric solutions and its impact on the space.

Speed, technology and emerging risk factors

The commercial space particularly has embraced parametric cover – and this is due to the escalating consequences that can be felt, as well as innovations in technology that enable providers to better predict the onset of a natural catastrophe. 

Martin Hotz, Head Parametric Nat Cat, Swiss Re Corporate Solutions says that Parametric insurance is being embraced across various sectors, including manufacturing, retail, energy, hospitality, and the public sector, and while it’s difficult to identify the precise events that sparked this trend, the catastrophic 2017 hurricane season (marked by Harvey, Irma, and Maria) likely played a significant role in driving its wider adoption. 

“In the aftermath of every single NatCat event we are reminded of how valuable a highly transparent and fast-paying insurance policy can be.”

He continues: “ There has been a realisation in the market that while conventional insurance may be a good instrument to cover property damage and business interruption, NatCat events usually cause rippling effects, such as supply chain disruptions. As financial losses from nat cat events go beyond property damage and business interruption, parametric insurance plays an increasingly important role in fostering companies’ and society’s resilience by providing a quick payout and covering certain financial losses that otherwise would be uninsured.”

Nelson Castellanos, Chief Partnerships Officer (International) at HDI Embedded, also believes that the speed in which parametric solutions can be triggered and settled, has played a large role in its rising popularity. He says: “Traditional insurance processes – from investigation, to authentication and compensation – can take time. Parametric insurance offers a faster alternative, with predefined payouts based on clear, objective triggers (think rainfall exceeding a certain level or earthquakes reaching a specific intensity) streamline the process, leading to faster and more transparent settlements.”

Castellanos notes that the shift is fuelled in part by “exciting” advancements in technology. Improved data collection methods, like sophisticated weather monitoring and powerful satellite imagery, coupled with advancements in big data analysis, allow for more accurate measurement of predefined triggers, ensuring payouts are made efficiently.

It’s a combination of circumstances that is seeing parametric offerings on the rise, starting with emerging risks, which are predominantly related to climate change, and are difficult to insure due to their profile, says Jaime Esteban Molina, Director of Product Management and Strategy, Fadata. He also points out that it’s a solution that protects insurers against fraudulent claims. 

“Parametric insurance better manages larger amounts of claims quickly, with low fraud risk, which provides an immediate relief on administrative costs for insurers, especially when a catastrophic event occurs. Governments have even been enabling parametric offerings to support financial relief against disasters in their communities.”

Offering a service that swiftly accommodates the needs of customers in the wake of a NatCat event is also a key factor that is driving demand, says Molina. “Parametric insurance delivers faster payouts with straight-through-processing of claims, again, reducing administrative burden, but also satisfying modern customer demands, ultimately improving customer satisfaction. Trust is also built between insurers and customers as there is a confidence that in certain circumstances, customers will receive a payout regardless of assessment.” 

Molina continues: “To date, parametric insurance has been held back by insurers with a risk-averse mindset, but as education of the benefits and familiarity improves, adoption is becoming more wide-spread. Add to this, emerging technologies, particularly in weather events, such as satellite imagery, censors and generally a larger cache of data and accessible information to utilise, insurers are becoming more comfortable with exploring the options.”

Evolving use cases in the parametric space

But where else can these new and exciting characteristics be applied in the insurance industry? And will we see many more sectors turning to parametric solutions – and away from more traditional models of insurance? Molina thinks so – especially as the AI revolution continues to expand. 

He says: “Advances in sensor technology, data analytics and AI all contribute to broadening information indexes on a diversity of events, making it possible for Parametric insurance to react quickly and analyse potential impact in many new risk areas. Climate change, cyber-attacks, pandemics are all measurable risk areas which can be increasingly applied to a range of insurances, and coverages are vast – from booking cancellations to drought. With this in mind, use cases of parametric cover should see exponential growth across the board.”

Meanwhile, Castellanos notes that we’re seeing the parametric insurance trend across a number of sectors because so many industries are impacted by natural events. He points out that Agriculture, where droughts, floods, and unpredictable weather patterns can wreak havoc on crops, leaving farmers “scrambling” is benefitting. “Parametric insurance steps in as a knight in shining armour, offering quick financial relief based on predefined weather triggers like low rainfall or scorching temperatures,” he says. 

Likewise, Tourism and Hospitality are also seeing a big impact of this type of insurance, where a single event can incur massive losses. “Picture this: a paradise island paradise paralysed by a hurricane. Hotel bookings vanish, and property damage mounts. The tourism and hospitality industry is highly susceptible to the whims of weather and natural disasters. 

Adverse weather can translate to significant losses due to cancellations and damaged infrastructure. Here’s where parametric insurance shines. Hurricanes and typhoons, particularly in tourist hotspots like the Caribbean and Southeast Asia, have exposed the need for faster, more reliable insurance solutions.”

The energy sector is another beneficiary. As renewable energy sources like wind and solar gain prominence, they remain vulnerable to the unpredictable nature of weather. Parametric insurance mitigates this risk by offering swift payouts based on predefined weather conditions.

Traditional flood insurance, on the other hand, often entails lengthy damage assessments and cumbersome claims processes, leaving property owners in a bind after a flood. Parametric insurance simplifies this ordeal by providing quicker, more efficient settlements based on specific flood data.

Weather and data focused sectors benefit the most from Parametric solutions

Hotz says the main focus for parametric cover is weather related because  on many occasions, this goes hand-in-hand with government support. He points to Swiss Re’s own work with NatCat parametric solutions, to illustrate. “An inspiring success story is Parametric QUAKE, a Swiss Re Corporate Solutions product that provides earthquake insurance based on the intensity and geographic spread of shaking,” he explains. 

“The State of Utah, a customer of ours since 2017, received a partial payout after a 5.7 magnitude earthquake hit the Salt Lake City area in March 2020, during the COVID-19 pandemic. The main objective of the state’s policy was to supplement their traditional earthquake insurance and cover deductible expenses through the solution’s quick payment and flexibility. With this product, we enabled our customer to swiftly deploy much needed funds right after one of Utah’s strongest earthquakes in nearly 30 years.”

Where does Parametric fail? 

While it seems as though parametric solutions offer a silver bullet in challenging situations, it’s not a model that could successfully broach all sectors. 

Molina says much of this is related to outlay and limited coverage types. “Where risks cannot be quantified or objectively measured, parametric insurance is not suitable, limiting the feasibility somewhat. Parametric solutions could also require relevant investment to commercialise as it requires integrations and data ingestion. This is also where insurers need to ensure that they have the relevant technology in order to be able to implement, but at this stage, this really should be a top priority for insurers anyway, as we move into a digital insurance era.” 

He points out that parametric insurance also comes at a price for insurers due to reliable claims payments when the trigger is met, in contrast to indemnity insurance, which doesn’t always necessarily pay out when there is an insured loss. “A classic example would be in instances where policyholders can opt out of claims to protect their non-claims discount and prevent a premium increase at renewal. This choice is removed. The automatic payments also impact an insurer’s claims ratio which naturally increases premiums, so policyholders are also paying the price. It is definitely important to weigh the pros and cons.”

“Parametric insurance is not suitable for insurance cases without predictability or where data is subject to challenge. Car insurance being the best example. There is no clear objective data source that can reliably certify certain types of claims, which makes them subject to fraud which increases risk for this type of insurance. The risks associated with insurance are reduced by data accuracy and quality, both of which are key in order to offer parametric insurance.”

He goes on to explain that there is basic risk in a parametric insurance policy, just as there is in traditional insurance due to retentions, sublimits, and exclusions. It’s always a tradeoff. Parametric cover is fast and compensates for losses that might otherwise be excluded. However, since the payout is predetermined, it will never perfectly match the actual loss.

Technological innovation and the future of parametrics

Data is critical in determining the outcome of parametric claims – and it will continue to be the mainstay of the space as the insurance industry develops digitally – and adjusts to ever more erratic climate events. Hotz says: “Data is the backbone of every parametric policy as it enables us to pre-agree on the potential losses with greater confidence. More and better data insights will be a key catalyst for product innovation and increasing adoption in this segment.”

Molina agrees and believes that big data will play a significant role in processing parametric insurance. “As the technology to structure and utilise the data evolves, the more reliable and indeed valuable it becomes. Equally, the proliferation of IoT also plays a role for speedy data collecting. Parametric cover is hugely dependent on monitoring and exposure assessment, so innovations in GIS and Satellite imaging have the potential to impact greatly on the future of parametric cover. Blockchain provides insurers with guaranteed transparency and impossibility of data tampering for peace of mind, and the means to perform straight-through-processing and payouts, which is of course the primary point of claim to deliver high level service for policyholders.” 

Castellanos also believes that the future of parametric cover will be defined by data and automation because the widespread use of Internet of Things (IoT) sensors in agriculture, weather monitoring, and buildings will produce vast amounts of real-time data on potential triggers. He says: “Analysing these vast data sets will then facilitate more sophisticated risk modelling and allow for the creation of more precise parametric triggers. And machine learning algorithms will be vital in processing this data to identify new risk patterns, leading to innovative parametric insurance products.

“In terms of automation, we’re already seeing the value of blockchain technology to automate claim settlements when predefined triggers are met, ensuring faster payouts to allow smart contracts. Automated processes will also simplify the administration of parametric insurance policies, reducing costs and enhancing accessibility.”

Ultimately, the streamlined nature of parametric insurance can translate to lower administrative costs (no claims processing ultimately means cheaper costs), which also potentially leads to reduced premiums. This makes insurance more affordable and accessible to underserved markets, ensuring a wider range of people can benefit from its protection.

Parametric insurance is also a favourite choice for customers because it allows for faster payouts, simplifies the claims process and leads to quicker financial assistance after a triggering event. This provides greater transparency for customers over their insurance, with predefined triggers to eliminate ambiguity and disputes regarding payouts; and cost-effectiveness, as streamlined administration can potentially lower premiums.

He adds: “Parametric insurance isn’t limited to traditional risks. By focusing on measurable triggers rather than specific types of damage, it can even address previously uninsurable concerns, like cyberattacks or disruptions in supply chains. This broader coverage offers a vital safety net in today’s complex world.”

Report by Joanna England