One of the major lessons of the Covid-19 pandemic is that we live on a volatile planet. The pandemic has in part spurred consumers to look for coverage related to risks resulting from climate change, natural disasters, rapid urbanization, health crisis, or political unrest.
However, studies show that traditional insurance covered only 40% of the $140 billion of economic losses from natural and man-made disasters in 2019.
The challenge for the slow-moving insurance industry is to find ways to provide coverage for a rapidly changing risk environment. A new and creative approach to insurance is needed to help those affected recover their losses. Insurance buyers are actively searching for affordable insurance solutions that offer a fast claims resolution process.
Some carriers have introduced parametric insurance solutions as a creative alternative to traditional products. Parametric insurance (also called index-based insurance) has great potential to fill the gap left behind by traditional insurance.
This type of insurance is called parametric because it pays out when a defined "metric" such as wind reaching a certain speed or an earthquake of a particular magnitude occurring in a specified location. So, a parametric insurance policy doesn't address a specific loss or physical damage. Instead, it pays out a pre-defined amount based on a trigger event.
Let's go into more detail and find out why parametric insurance solutions are cited as the top product development priority for North American and European carriers.
Defining Parametric Insurance
While traditional insurance pays out a claim based on the value of the loss suffered, parametric pays out only upon the occurrence of a specified event. So, the amount paid out is not based on the cost of the loss incurred but rather on the size of the event — wind speed, earthquake magnitude, water levels, and amount of rainfall are the most common examples.
However, triggering events don't have to be weather-related; business interruption caused by problems in the supply chain can also be a trigger.
Different Components Of A Parametric Policy
Parametric insurance is elegant in its simplicity. A parametric policy consists of two critical elements: a triggering event and a payout process. These two features determine the scope of the policy, pricing, and the conditions under which the insured receives financial reimbursement.
Let's go over the key features of an index-based insurance policy:
- An event taking place and reaching a certain size.
- An independent, third-party source, providing the relevant information, is a crucial requirement for the parametric cover as the entire payout is based on this data. This gets rid of any potential conflicts of interest and provides transparency regarding the data used.
The National Oceanic and Atmospheric Administration would be an example of a relevant third-party agency. As a backup measure, there will typically be other third-party agencies that can provide accurate data if the primary agency is not functioning properly. For instance, a powerful earthquake damages the sensors of a relevant agency, which prevents it from reporting the official magnitude.
Together, these elements offer insureds a quicker claims process — the triggers are independently validated, which automates the payment.
A Quick Note On Parametric Insurance
Since payments are based on a triggering event and not on the actual physical damage, the amount paid out may be lower or higher than the actual loss. This is called basis risk and it's something that both insurers and insureds need to consider.
Proof-Of-Loss is Required in the United States
The term "parametric" only refers to an event that triggers a payment. Therefore, its application goes beyond the insurance industry. For example, other risk transfer products, such as derivatives, can be considered as parametric triggers.
To distinguish parametric insurance from gambling, regulators in the U.S. require "proof-of-loss." The insured has to prove that an actual loss had occurred before the payment is made. However, showing proof of a loss isn't necessarily cumbersome — U.S. regulators accept things like images taken with drones and text messages from customers.
So, the U.S. insurance market has found a workaround that preserves the main advantages of parametric solutions while adhering to regulatory requirements.
Advantages of Parametric Insurance Policies Over Traditional Insurance
While parametric insurance solutions may still be in their early stages, the ability to deliver automatic payment in a data-driven world helps it fill the gaps created by traditional indemnity.
One of the challenges in insurance is setting appropriate rates.
In traditional indemnity, pricing the risk of a loss is not easy. Oftentimes the price set by traditional insurance is so high that no one buys it. This is the case with flood insurance today — conventional insurance is expensive with a slow and cumbersome payout mechanism.
The insured generally has the benefit of having more information of their own risk than the insurance carrier. Parametric solutions remove this information imbalance. Both parties are privy to the same relevant data about the chances of an event happening.
That's the reason why parametric insurance is becoming an appealing option to non-insurance capital providers because there no need for them to analyze the risk in their clients or their assets.
Also, one of the major benefits for insurers is that every parametric policy offers fixed liabilities. As a result, insurance providers can calculate the total amount of liability with a high level of certainty. This is especially important for low-frequency but severe events.
The ease of pricing offers another benefit — a simplified underwriting process. Since risks are priced based on the likelihood of a trigger, parametric insurance provides fixed and capped payouts. This gives insurance carriers the ability to generate more sales by reducing how much time and information is needed to quote a policy.
Innovative & Customized Insurance Policies
Conventional insurance policies generally use standardized phrasing. On the other hand, a parametric policy is a custom-built product with tailored requirements. This wording reflects the customer's specific needs, in line with their risk assessment.
A parametric insurance product is flexible - a policy can be valid for a few months to several years.
Also, a parametric policy might be designed to pay out 50% or 75% of a pre-agreed limit for a Category 3 hurricane and 75% for a category 4 hurricane.
So insurers have many different ways of customizing their parametric solutions.
Better Customer Experience
Parametric insurance combines speed and certainty to deliver an outstanding customer experience. Therefore, it increases the likelihood of insurers pleasing their customers, which builds trust and loyalty. The customer knows the exact amount to be paid and under which conditions.
The promise of a seamless payout mechanism contrasted with the tiresome process administered by adjudicators in traditional insurance is too good to ignore.
While determining actual physical damage with conventional indemnity insurance can be both complex and slow — often taking weeks to months to settle - parametric insurance pays out in days of an event.
Instant payouts mean that policyholders don't have to use their savings or get a loan to cover their losses while they wait for the insurer to react.
Provides Assistance When It Matters The Most
Quick payments play an especially vital role for victims of natural disasters. Agencies that are responsible for disaster response benefit from receiving funds immediately because resources can be deployed quickly when it's most critical. United Kingdom's Foreign, Commonwealth & Development Office concluded that fast availability of funds improves disaster response and mitigates losses.
Major Carrier Offers Parametric Solutions
Recently, Lloyd’s introduced a parametric insurance policy in New Zealand. The insurance giant wants to use parametric products to enhance coverage through simpler insurance products.
The policy automatically pays within days of an earthquake. Therefore, Lloyd's delivers affordable coverage and fast claims payments while meeting customers’ needs following an earthquake.
The Essential Tool for Delivering Parametric Coverage
Parametric solutions are common in industries such as agribusiness and catastrophe insurance where triggers are easy to identify.
However, the hyperproduction of data is exponentially increasing the number of risks that can be covered by parametric insurance.
Insurtechs are offering consumers protection from different types of risk — covers include anything from flooding to a canceled flight or not enough snow on a winter vacation. And financial reimbursement is instant!
Parametric insurance is a winning strategy because this type of insurance gives customers the ability to choose the protections they want. And using objective data sources to churn out premiums in real-time with a quick payout scheme gives insurers the ability to meet consumer expectations.
Building Parametric Insurance Solutions with Hyperon
The demand for tailored and niche parametric insurance products will only continue to grow.
Designing parametric covers that meet both regulatory requirements and are attractive to buyers often involves multiple parties. This is why insurance carriers use business rules engines to deliver relevant products on the fly!
Hyperon is a hyper-efficient business rules engine that can be configured in real-time with no code. Its user-friendly interface gives underwriters a bird’s-eye view of all the processes, enabling collaboration from team members across the company.
With little initial training, non-technical users can create and manage their parametric policies in Hyperon without any help from IT.
This user-friendly business rules engine shortens the development and deployment time of complex parametric insurance products down to minutes, allowing companies of all sizes to make better decisions and respond to market changes immediately.
Hyperon helps you represent the complexity of the world.
If you’d like to learn more about how insurance carriers can increase their market share with Hyperon, then schedule a free call with us today.