By Daniel Sacks, Analyst – Insurance Consulting at Lane Clark & Peacock
What is parametric insurance?
Parametric insurance provides a payout based on the occurrence of a loss-causing event occurring rather than covering the actual losses incurred due to the event. Once the pre-defined event has occurred or is exceeded, an exact payout to the client is triggered. Typical triggers could be a 7.0 earthquake, a category five hurricane or a certain amount of rainfall in a specific geographic region. Alternatively, an index, verifiable by an independent third party, could be used, such as crop yields, power outages or commodity prices. The key criterion for an insurable trigger is that it is measurable and has happened by chance.
What are the advantages and disadvantages of parametric insurance?
Some key advantages to parametric insurance are that it is the most suitable option in some situations.
• Speed of compensation. Given that individual damage assessment is unnecessary, compensation can be received quickly, even in days or hours. This is particularly relevant in emergencies, where the speed of the financial response is key to recovery.
• Predictability and transparency. The precise definition of parameters and pre-established thresholds eliminates ambiguities and possible conflicts over the extent of damages. Insurance contracts will be less complicated, reducing the chances of litigation.
• Coverage of traditionally non-insurable risks. It allows coverage of risks challenging to quantify with conventional insurance, such as certain geopolitical or market risks, by focusing on measurable and verifiable parametric triggers.
• Reduction in operating costs. Automating claims and claims handling, eliminating damage verification, and simplifying reserving processes can significantly reduce administrative costs, allowing for more competitive premiums.
• Accessibility in emerging markets. It has excellent potential in regions with little insurance infrastructure. In vulnerable areas, such as certain developing countries, it offers practical solutions for risk management that haven’t been traditionally available.
• Empowers long-term resilience. Parametric insurance goes beyond providing financial relief. It allows companies and individuals to invest in long-term resilience and infrastructure improvements, such as flood defences, thereby preventing potential future payouts. This sense of control and proactive risk management is a key advantage of parametric insurance.
Parametric solutions also have potential drawbacks. The most obvious is the potential for greater basis risk (i.e., a mismatch between payout and actual losses) than would be the case in a normal insurance contract. However, advances in data analytics and AI have the potential to help insurers mitigate basis risk by designing policies that more accurately capture the impacts of the underlying event.
What are some current parametric solutions in the UK?
Here are three great examples of parametric solutions offered in the UK for three different challenges. Each solution has come from an Insurtech platform that graduated from the Lloyd’s Lab accelerator programme. FloodFlash is a commercial flood insurer that uses rain sensors to measure water levels as a parametric index for insurance payouts(1). Before FloodFlash creates a quote for this policy, insured parties choose the location of the sensor on their site, the amount they wish the payout to be, and at what level of rainfall it will be triggered. Policies are, therefore, bespoke to each customer, allowing for exact customisation depending on individual requirements.
Blink Parametric provides parametric solutions to a travel insurance broker, Just Travel Cover. They track the flights of insured parties to accurately track any delays or cancellations(2). If a delay or cancellation happens, they provide an immediate solution for the customer, whether it be lounge access, hotel accommodation, new flights, or a cash payout.
Skyline Partners has collaborated with NFU Mutual to offer parametric insurance in agricultural markets(3). The Daily Heat Stress Insurance uses the Temperature Humidity Index to monitor weather data and automatically payout should the threshold be exceeded. This innovative solution provides farmers with fast and easy financial cover, with payments released in pre-defined periods, helping them manage the risks associated with extreme weather conditions.
Where to next?
Data availability needed to help design suitable triggers will be the key to further growth in parametric products. Advancements in technology allow insurers to use satellite imagery, internet-enabled devices, and real-time data analytics to provide increasingly customised policies, particularly in vulnerable areas such as agriculture. Market research suggests an expected growth of 6.6% pa from 2024 to 2033, based on a current market size of over $18 billion(4), so this isn’t just a niche market.
Overall, the potential for growth in parametric solutions is immense, offering a promising future for the insurance industry. With advancements in technology and increasing data availability, the scope for innovative and efficient parametric products is vast, inspiring optimism about the future of insurance.
References
1. https://floodflash.co/
2. https://blinkparametric.com/blink-parametric-platform/blink-flight-disruption/
3. https://www.nfumutual.co.uk/news-and-stories/addressing-climate-challenges-in-agriculture/
4. https://www.alliedmarketresearch.com/parametric-insurance-market-A14966
|
