Most insurance payouts compensate for direct losses—and only after what can be a long claims process. But finance executives should know the ins and outs of a growing market segment that is structured differently: parametric insurance. Parametric coverage pays when a certain objective triggering event occurs, regardless of the actual losses suffered.
That’s different, of course, than traditional indemnity insurance.
For example, if a hotel’s occupancy rate (“the index”) drops below 20% (“the trigger”), an automatic payout is generated no matter the cause—a storm, war, wildfire, earthquake, or terrorist attack. Parametric insurance does not cover the actual event loss, but rather the approximate loss.
While parametric (or index-based) insurance has been around for awhile, global insurance giants are promoting new parametric offerings. Swiss Re Corporate Solutions, for example, is automatically paying Hong Kong business clients if a certain-level typhoon warning is issued; Singaporean retailers if too much pollution haze hangs in the air; and European shipping companies if river levels fall below a certain depth.
Likewise, Axa covers French vineyards if frost hits within an agreed upon calendar window and U.S. car dealerships if hail of a certain size is recorded. The insurer also just inked a deal with a Chilean forestry company that pays out if wildfires hit a certain percentage of the company’s land (as measured by a satellite).
Clarity is a major part of parametric’s appeal to businesses, says Paul Ramiz, a director for innovation and solutions at Aon. There are no long claims investigations or waiting while a loss is confirmed, and presumably fewer disputes. Aon began selling weather-related parametric coverage in 2012 and added non-weather-related parametric products last year.
“The claim is paid out efficiently, cleanly, and quickly,” says Ramiz. “There are fewer people in the [processing] chain. The quickest claim has been paid in a week.”
The catastrophe bond market, which developed in the mid-to-late 1990s,2019showed the appetite for alternative risk transfer mechanisms. Swiss Re, for example, offered major California earthquake coverage in 1997, but considering the massive payouts it might have been on the hook for, it transferred some of the risk to the capital markets.
Meanwhile, developing markets, such as the Caribbean and Latin America, have long featured coverage with specific triggers, says David Eckles, professor in the risk management and insurance program at the University of Georgia’s Terry College of Business. But those have often been in micro-insurance, which protects low-income people, and where the size of the loss might not necessarily merit a claims investigation.
Appetite for corporate-scale parametric coverage has been building in highly developed markets such as the United States, Europe, and Australia.
In an age of global complexity and in which risk management departments are getting better at managing pure financial exposures, parametric triggers look appealing. Businesses can be devastated financially without necessarily suffering physical damage. Losses can occur even if the underlying asset is not within the insured’s control. And parametric coverage can fill the protection gaps from deductibles or from perils that are excluded in indemnity insurance contracts.
In developing markets, more trustworthy data is making parametric coverage viable now, says Karina Whalley, business development manager for Axa’s global parametrics group. High-quality government satellites can track happenings on the ground even in geographic locations where reliable information arbiters weren’t previously present—and the data is freely available.
“We’re seeing better and better satellites being launched, both temporally and spatially. The granularity has really improved,” Whalley says. “That has propelled the market forward.”
CFOs like parametric payouts because they can smooth out quarterly profits and losses, says Christian Wertli, head of innovative risk solutions at Swiss Re. Coverage also helps assure a risk-minded board that a company’s executives are prepared for a range of harmful possibilities.
When looking to buy parametric coverage, however, finance executives should bear in mind that they’re weighing the certainty of payout against the “basis risk”—the potential mismatch between the policy’s parameters and the underlying risk exposure. A vineyard’s wine grapes could be destroyed even though the thermometer does not hit the designated low temperature range.
“It’s a great policy for peace of mind in that you know whether you’ll get paid [in the event of a loss], but there’s also quite a bit of uncertainty as to whether the trigger will line up with your actual losses,” Eckles says.
Parametric payouts are easier without the usual claims adjusters, legal disputes, or complex business-interruption calculations involved. But since most parametric contracts are bespoke, the real work is done upfront in arriving at (and properly measuring) a business’ appropriate trigger, says Nigel Brook, partner in the global law firm Clyde & Co.
Brook was a co-author of the firm’s 2018 report on parametric and inclusive insurance. The report cited a policy issued to the East African nation of Malawi. The policy covering drought was not immediately triggered even though there was widespread crop failure. Later investigations revealed that farmers in Malawi had switched to a different crop with a shorter growing cycle. When this data was put into the model, it created a more accurate estimate of the drought-affected population, and a payout was triggered.
“What if, what if, what if—have you really thought out all the what-ifs? You need a well-designed trigger—otherwise it’s calculated to give rise to disputes,” Brook says. “And then also make sure you have dealt with all the contingencies that could arise that could undermine the contract, such
as faulty sensors or [an incorrect] data source.”
More and more policies with parametric triggers are turning up. The question is whether they’ll become mainstream. At present, only a few companies offer parametric coverage directly to individuals. An organization called JumpStart promises to pay residents a fast, flat, no-deductible sum if their area is hit by an earthquake, whether that money is used to repair a damaged home or if the insured just wants to relocate.
Insurers like Swiss Re are bullish on the entire market. In addition to its corporate coverage in nearly a dozen countries, the company just launched fully automated parametric plans for smaller clients.
“The whole industry is still evolving, and obviously the better the data gets and the more computer power we have, the more creative Swiss Re can get with solutions,” Wertli says. “We’ll definitely see more in this area.”
Lynn Freehill-Maye is a business and sustainability writer whose work has appeared in The New York Times, The Washington Post, and The Wall Street Journal.