By Patrick Kelahan, CX, engineering & insurance professional, working with Insurers, Attorneys & Owners. Article first published on Daily Fintech.
Insurance is a known product- in return for payment of a premium a policyholder can expect (within the terms of the insurance contract) indemnification for a covered loss. The loss occurs, a claim is made, the claim investigation proceeds, an estimate of loss is made, and a claim settlement is paid. Outside of health and life cover this is the typical framework of the contract that is insurance. The value of the insured property is determined at policy inception, a premium is generated based on underwriting guidelines re: probable loss characteristics for covered perils, and the insurance contract is bound.
A nagging problem with that centuries old framework is the need to prove a value of property, to experience an occurrence or claim, prove the claim, and wait for indemnification- if the claimed damage is covered by a policy. There are many perils that are not covered by most policies, e.g., flood, earthquake, long-term effects of weather (drought), wear and tear, and so on. Additionally, in some circumstances the nature of the damage exceeds the ability of individual policyholders to adequately respond- of particular note flooding, cyclones, earthquakes and agriculture issues where damage is a regional problem that simply requires regional response.
Parametric insurance, or, “a type of insurance contract that insures a policyholder against the occurrence of a specific event by paying a set amount based on the magnitude of the event, as opposed to the magnitude of the losses in a traditional indemnity policy” (NAIC) is becoming the insurance option that allows a policyholder a payment for an occurrence or circumstance that can be defined and established at the inception of coverage. An apt example of a parametric option is provided by Jumpstart, a firm that will make payment to U.S. policyholders when a seismic event occurs and reaches a ‘peak shaking intensity’. The firm simply monitors US Geological Survey data, when a trigger event occurs the firm identifies policy holders within the affected area and sends them a payment. No claim action needed by the customers- the agreed parameter occurrence happens, the policy pays. Traditionally an earthquake would need to damage covered property, the respective property owner would need to have earthquake coverage (an optional cover in most jurisdictions), a claim be filed, investigated and settlement made. Indemnification for damage. Parametric products simply promise payment if an agreed parameter is met- in Jumpstart’s case a ground shake of a certain magnitude.
One must keep in mind that parametric insurance is not intended to be a full ‘indemnification style’ coverage- it’s meant as a first payment option for traditionally covered perils, and an alternative/immediate recovery source for perils that may otherwise not have practical insurability. Prudent insureds may even layer parametric cover onto traditional policy coverage, almost to act as a hedge against a large deductible.
Applying the method to the market is not as simple as generating the policy- there must be an identified, measurable trigger for the respective policy, and the carrier needs to be able to conduct that ages-old act- apply probability of risk to the potential payout. What makes that exercise more direct than with indemnification policies is that there is a specific trigger, and there is an agreed payment. If X occurs, amount Y is paid. Claim adjustment expense is administrative cost only, and customers may not even have to report or confirm the triggering event as the carrier may have methods in place to automatically confirm the triggering event. Consider if the parametric agreement is captured as a smart contract in a distributed ledger format- perhaps an inroad into Blockchain as an equal to other methods in administering insurance? (see Etherisc )
So what uses are there for parametric cover? Not everyone is in a high frequency earthquake zone, and awareness of parametric cover is relatively low. If we look to the current placements of the cover there can be an understanding of where the industry sees opportunities. Travel insurance options have been noted, and exemplify how the cost of inconvenience can be reimbursed. There are insurance organizations that have established themselves as industry experts, e.g., Swiss Re, who have initiated parametric plans in collaboration with individuals and governments in many areas for:
- Crops (Better Life Farming) – also includes comprehensive agricultural advice
And the firm’s thought process does go beyond individual policyholders to regional parametric programs that partner with government agencies, for example, Sovereign Insurance (options for regions across the globe), or other organizations such as Hiscox Re ILS with ongoing involvement in a variety of initiatives including the linked Philippines plan.
Broad spectrum parametric programs have been in place for some years to assist governments in more prompt recovery from disasters:
- Caribbean Catastrophe Risk Insurance Facility (CCRIF)- provides post-disaster assistance to nineteen Caribbean and Central American countries, is funded by various governments and government organizations, and makes payments to participants’ governments for earthquake, hurricane and excess rainfall triggered events
- African Risk Capacity (ARC)- planning and guidance program that also funds/administers a primarily agriculture parametric cover for participating countries
And in addition- there are initiatives being developed as this article is written where counties in China are being used as model plans for regional parametric cover, particularly earthquake-prone areas and regions subject to landslides (see Insurance Asia News).
Are there also funding opportunities for parametric insurance, both from a provider and recipient standpoint? One would think so as this cover fills a gap for recovery, and, in combination with existing schemes for catastrophe and disaster bonds capital can be encouraged to make a foray into parametric plans. Insurance linked securities (ILS) that have taken some hits during the last few years with unexpectedly frequent and unexpectedly severe cost events might have more stability functioning within a more predictable loss environment of parametric programs. Improvements in data collection, analysis, AI and immediacy of event data have all contributed to the increasing viability of the programs.
So the unexpected benefit and under-publicized parametric insurance industry may be the best hedge for many against uninsurable (in a traditional sense) perils, and for almost anyone that needs a source of immediate payout when a trigger event occurs. Picture the coastal towns of the U.S. after a major hurricane as recipient of a parametric cover distribution, a ‘prime the pump’ amount to give some immediate recovery light for residents, or tsunami victims whose livelihoods have been washed away receiving funds to re-establish businesses, or wildfire victims who need immediate distributions until primary insurers can catch up. Yes, insurance payments can be made without the burden of proving a claim- set the trigger point/parameter, and count on the underutilized benefits of parametric insurance.