There’s a not-so-new innovation in insurance that’s captured the attention of the market: parametric insurance. According to a 2022 report issued by Allied Market Research, in 2021 the global parametric insurance market was worth $11.7 billion, and by 2031, it’s forecast to hit $29.3 billion.1
One look at the staggering projections, and it’s no wonder insurers across the country and around the world are incorporating this risk transfer tool into their portfolios. “Parametric insurance is gaining traction in the industry with the continued evolution of big data and the creation of credible indexes, sophisticated technology for monitoring triggering events and the simple settlement process that offsets the uncertainty created by inflationary impacts in traditional lines,” confirms John Lopes, Executive Vice President, Alternative Ventures & Programs at Nationwide.
Understanding parametric insurance
Parametric insurance, which is sometimes called parametric risk transfer, dates back to the 1990s, although it didn’t become popular at the time. With a parametric insurance policy, the insurer and the insured agree upon a pre-determined threshold for payment, such as wind speed or the magnitude of an earthquake, as well as a payment amount based on expected losses associated with such an event. If the threshold is met and the loss is confirmed, the insured receives a payment for the predetermined sum.
“It’s a simple concept. When the condition is met, the payment is triggered,” confirms Kevin McLain, Senior Consultant at Nationwide. “The process is databased, exact and provable, and insureds know what the potential payment is from the very beginning.”
In contrast, a traditional insurance policy protects assets, and the claims process takes time to conclude. First, the insured has to report the loss to the insurer and share supporting documentation. Then, the insurer assesses how valid the claim is, evaluates if the loss is covered by the policy and determines the amount of the settlement offer, if there is one.
“There can be some uncertainty for the insured, who won’t know how much they’ll receive for a given loss until after the claim is settled,” McLain adds. “Parametric insurance is more clear-cut, and insureds know exactly what the payment will be if the specific condition is met.”
The upside for insureds
While parametric insurance policies can cost more than their traditional counterparts, they offer many benefits to insureds beyond their simple structure. With parametric insurance, the insurer is monitoring data to determine if the threshold for payment is met and will contact the insured if and when that occurs. This streamlined claims process saves time and limits confusion for the insured, while ensuring payment is processed quickly.
Because the policy is simple and uses independent, publicly available data sources to track events and trigger the claims process, there’s typically no dispute over what’s covered and what’s not.
The speed of this process means insureds get paid more quickly, which can help them get back on their feet as soon as possible in the aftermath of a triggering event instead of waiting for a settlement offer. According to Michael Marks, Director at Nationwide, this can happen within weeks or even days.
How insurers are adding value with parametric insurance
Savvy insurers are adding parametric insurance to round out their portfolios as catastrophes become more frequent and severe.
“With a traditional policy offering, you have to guess or set limits at how much damage will occur relative to what you have insured,” says Marks. “Insureds can use parametric insurance to balance their risk exposure and cover risks that are not otherwise easily insurable using specific parameters rather than physical loss.”
Parametric policies enable insurers to have fixed severity for the parametric segment of their portfolios and unknown severity for the rest, which can limit their exposure during catastrophe-heavy years and help them remain solvent.
“It’s a lot easier to plan financials when you don’t have as many variables,” Lopes explains. “Parametric is a tool that can help insurers better manage their book.” In addition, the cost of managing a parametric policy is lower for insurers because underwriting costs are fixed and claims expenses are lower.
The future of parametric insurance
With parametric insurance poised for explosive growth in the coming decade, opportunities abound.
“The pandemic got us thinking differently,” notes McLain.
Many insurers will lean into parametric insurance to provide another option for insureds, and the applications are almost limitless.
“Parametric is not just for weather or natural perils,” Marks says. “It has the potential to move into other markets, such as management liability and specialty, cyberterrorism and other types of risks that don’t trigger physical damage but have a financial impact on insureds. Parametric will fill that gap.”