Parametric insurance has grown in the last five years. While still a somewhat niche type of protection, it represents an exciting innovation for the industry.

Though it has been around since the 1990s (albeit in a limited role), parametric remains unfamiliar. Growth in data sets, thanks to satellites and other big-data sources, has expanded the possibilities of parametric insurance.

The name “parametric” helps define how the coverage is structured. Parametric insurance sets parameters around a specific set of metrics. A parametric policy establishes predetermined parameters and payments – agreed upon by both insurer and customer – for risks that can be objectively measured and verified by a respected third-party authority. Once an agreed-upon measurement is confirmed and triggered, and the customer can attest to or show losses from that trigger, the claim is paid. There are many advantages, including no lengthy claims settlement process, which can improve cash flow to help a customer get back to business.

Parametric insurance can fill some protection gaps that traditional policies cannot. Parametric insurance also allows insurers to provide coverage for economic losses from a triggering event, sometimes called Non-Damage Business Interruption.

Examples of parametric insurance 

Consider a general contractor constructing a building. Wind, rain, snow and severe cold or heat may not inflict property damage, but they could sideline a crew. This, in turn, could cause financial hardship for the contractor because work stoppage can lead to expenses for various reasons: extended payroll costs, liquidated damages, fines for missed project deadlines, the need to rent additional equipment, etc. These items would fall under the concept of non-damage business interruption, giving rise to financial losses that are typically not covered by traditional property insurance. The contractor could, however, be covered if they had a Zurich Construction Weather Parametric Insurance policy covering the agreed-upon risks.

Three major benefits of parametric insurance

Parametric policies can offer many benefits, but three are especially important:

• Replaces subjectivity with objectivity: The agreed-upon parametric trigger brings an objective and independent measure to the insurance process. The event that triggers the payout and the mechanism used for payouts determine what will be paid to the customer, which is a clearer predetermined amount than with traditional solutions, where a claims adjuster needs to assess and determine damages.
• Quick claims processing: The claims payouts are agreed upon ahead of time, so the customer is typically paid in days or weeks, not months. Getting reimbursed sooner allows the insured to improve their liquidity and apply the funds to post-event emergency costs, restoring their business operations sooner.
• Provides a potential solution for climate resilience: As extreme weather events occur with greater frequency and impact, many businesses can use parametric insurance to help address these challenges. A recent quarterly report from the National Oceanic and Atmospheric Administration listed 20 weather/climate disaster events in the U.S. in 2021 with losses exceeding $1 billion each. And it doesn’t take a billion-dollar event to wreak havoc. As the frequency and severity of volatile weather events continue to grow, it’s harder to rely on historical weather data alone to predict future conditions. Weather parametric insurance can help.

Parametric possibilities continue to expand 

Parametric insurance can cover a broad spectrum of risks, provided they can be objectively measured. As data analytics continues to expand, metrics for a growing number of risks will be available. Consider these relatively new approaches to parametric insurance:

• Parametric insurance for Natural Assets was recently purchased by the Quintana Roo Government (originally purchased jointly with The Nature Conservancy and the Quintana Roo Government) to help protect the coral reefs and beaches of Quintana Roo, Mexico, in the event of a hurricane damaging its coral reefs.
• Parametric policies for agriculture have long been a part of the U.S. Federal Crop Insurance Program and continue to be developed. Zurich’s crop insurance business, which administers insurance products developed and regulated by the U.S. Department of Agriculture’s Risk Management Agency, writes several federal parametric crop insurance policies, such as Dairy Revenue Protection, Margin Protection, Area Risk Protection and Rainfall Index.
• Parametrix, a United Kingdom-based company, has introduced a parametric insurance model to technology-dependent businesses. The index-based coverage pays out automatically when service goes down under certain parameters. Covered are cloud outages, network failures, third-party system crashes and other hazards that can cause IT service downtime. Parametrix was one of eight finalists in the 2020 Zurich Innovation Championship.

Digging deeper into parametric insurance

There are a few characteristics of parametric insurance to clarify:

• Customers still need to prove loss. Parametric insurance should not be confused with a financial derivative, where an investor puts money against a metric like weather. In the U.S., one way that we ensure that this is insurance (as opposed to a financial market wager) is that there needs to be an attestation of loss.
• Customers cannot receive payouts larger than the actual loss. Insurers cannot over-indemnify a customer. In other words, the customer must establish their costs and expenses relating to the risk they’re insuring against, which would be the maximum the customer can be insured for.
• Parametric insurance is not necessarily more expensive than traditional insurance. The price of parametric insurance would depend on the subject of the insurance, and how the policy is structured. For instance, building in more deductible days will lower the cost of the insurance, but that might not give you the protection you need.
• Parametric insurance doesn’t replace traditional insurance. Instead, it complements traditional insurance and can be part of a well thought-out and sound risk management strategy. Because it can expand coverage by addressing broader categories of risk, parametric insurance can supplement traditional insurance.
• Although parametric insurance is a novel type of insurance, expect to hear more about it as its applications grow. The burgeoning role of data analytics and the influx of insurtechs seeking ways to put that data to work for customers will continue to expand the reach and possibilities of parametric insurance.