What is Parametric insurance?
Parametric insurance is an increasingly popular, risk management solution which allow for risks to be transferred or financed in non-traditional ways. These insurance solutions may offer alternatives to funding losses that are not possible with traditional insurance products.
Also known as index-based insurance, parametric insurance is a trigger-based solution. When a particular trigger or parameter are reached during an event (as an example an earthquake of a certain magnitude, or rainfall above a certain level), the insured is paid a pre-determined amount to cover potential losses. This can happen in a matter of weeks as opposed to traditional insurance policies where claims must first be processed, and losses verified before compensation is determined and processed. Traditional insurance claims can take months and sometimes years in comparison, which locks away valuable capital.
Parametric insurance vs traditional insurance
Indemnity (Traditional) Insurance
Requires historical loss database for product rating
Uses readily accessible data (e.g. weather)
Higher administrative cost
Lower administrative cost as no loss assessment required
Claimant needs to report claim (submission, assist surveyors, etc.)
Loss surveyors not required
Multiple peril coverage is possible
Typically, single peril coverage only
Can pinpoint specific risks by identifying the appropriate timeframe or index
Open to anti-selection (insureds at higher risk are likely to purchase)
Open to basis risk (e.g. not paid despite loss; payout more/less than actual loss)
Payout timescale is variable (could take a long time)
Able to provide a fast payout (within days or weeks)
Why use Parametric insurance?
Index values or trigger values immediately following an event can be verified very quickly, and this means claims are typically paid within days of an event occurring – releasing valuable liquidity for faster recovery
Parametric insurance can offer coverage that is typically excluded from traditional insurance, with no financial deductible.
Payments can also be used for a range of financial losses resulting from the event
Coverage can typically be customised and can solve for problems that are difficult to manage with traditional insurance – amongst other risks, cover can be arranged for risks like contingent business interruption supply chain exposures, hard-to-insure risks and more.
The availability of advanced data and analytics techniques have seen parametric solutions gain popularity. Parametric solutions are commonly used with natural catastrophe and weather-related risks, but innovations in this space are expanding these concepts into new areas.
Parametric insurance solutions in action:
Recent severe weather events in Queensland dramatically reduced the level of traditional insurance available for weather related perils. A contractor wanted to cover their costs (in the form of liquidated damages) arising from delays, such coverage is traditionally available to the Project Principal only under a Delayed Start Up (DSU) policy which the contractor was not party to. This left the contractor out of pocket in the event that weather or supply delays prevented work. Aon developed a parametric solution which incorporated a double trigger for the policy to respond whereby daily rainfall must exceed 10mm (first trigger) over 7 non consecutive days (second trigger). Importantly, payment is due within 10 days of finalising the event report and this is critical for project cashflow/liquidity. Under a traditional DSU policy, the insured would need to wait till the end of the construction period (circa 36 months) to determine eligibility for indemnity.
A Power and Energy client in Far North Queensland was unable to secure cyclone coverage for their assets (solar panels) under a traditional Industrial Special Risks (ISR) policy even though the site was built to withstand Category 3 windspeeds. Aon restructured the program by extracting the cyclone coverage from the ISR entirely and placing a wind parametric solution which had the added benefit of increasing contestability for the ISR. The construction of the site, along with historical cyclone activity with risk analysis utilising Aon’s Combined Hazard Information Platform (CHIP), were key factors in determining the payout structure of the parametric. The payout structure allowed for coverage at lower Category 3 wind speeds and more substantial payouts at higher Category 4 windspeeds. The combined efforts between placement and the parametric team resulted in full cyclone cover and more favourable ISR pricing.
An agricultural company comprising individual growers with exposures across Australia wanted to protect their crops against inadequate rainfall. Due to the widespread geography of the growers, the structure relied heavily on weather analytics. A 5km x 5km grid was used to identify grower locations and 20 years of rainfall data was analysed over 3-4 months to identify appropriate thresholds for each grid cell across the country, to improve product relevance to individual growers. This parametric solution has been in place for several years and has helped the client grow their business.