Parametric Insurance Is a Tonic for Insurers and Their Customers
Insurance has gotten a lot more interesting over the past few years. Helmed by progressive leadership, a growing number of insurance companies are making strategic investments in digital innovation. Harnessing smart technologies, insurance-focused startups are liberating insurers from the constraints of plodding legacy systems.
Parametric insurance is an innovation that has been attracting a lot of attention these days. Its appeal extends beyond insurers, having captured the interest of capital providers including banks, hedge funds, and pension funds.
Read on to learn about this game-changing approach to insurance.
What is parametric insurance?
Before we get to what makes parametric insurance so disruptive and present what’s happening in this rapidly growing field right now, let’s quickly summarize what it is and how it works.
Designed for businesses and consumers, “parametric insurance offers financial protection against losses that are often hard, or even impossible, to get insurance for.”1 So instead of compensating clients for their actual losses, these products cover the probability of the occurrence of a predefined event, typically a natural catastrophe or extreme weather conditions.
Events that trigger claims are based on predefined parameters; triggering events occur when these parameters are met or exceeded. Customers pay a premium; the insurer pays when a triggering event happens.
Trigger parameters include, but are not limited to:
- Number of infections during a pandemic
- Earthquake magnitude and shake intensity
- Hurricane wind speed
- Flood water levels
- Market index
- Crop yield
- Power outage
- Reported data breaches
To ensure legitimacy of claims, two conditions apply: predefined parameters must be met or exceeded by chance rather than intention, and you need to be able to model them.
The payout mechanism of parametric insurance products is based on how much a triggering event has met or exceeded a parameter. This is determined independently of the actual amount of loss; for example:
- $50,000 for every millimeter of cumulative rainfall above a specific threshold
- $10 million if a magnitude 7.0 earthquake occurs in a defined area
Parametric insurance requires more sophisticated structures than traditional insurance to avoid basis risk, which is the risk that the trigger parameter does not perfectly correlate with the underlying risk exposure. In such a scenario, a customer suffers a loss, but parametric insurance is not triggered. There are two ways of preventing this:
- Double-trigger events (partial payout for lower category storms)
- Staggered payout schemes (progressively higher payouts for stronger storms)
Therefore, compared to traditional insurance products, parametric insurance products are much more customizable and have higher structural flexibility.
Parametric vs. Traditional insurance
Swiss Re estimates traditional insurance covered only 40% of around $140 billion of economic losses from natural and man-made disasters in 2019.2 From a customer perspective, the time for innovative insurance products is right now.
Flexibility, customizability, and faster payouts are three key advantages that parametric insurance have over traditional insurance. Here’s a fundamental breakdown of their respective processes:
- Customer pays premium based on coverage type, coverage amount, and personal info (e.g. age, medical history, credit score)
- Insured property is damaged; the customer incurs losses
- The insurer pays out weeks or months after loss assessment and investigation
- Customer pays premium based on predefined parameters of one or more triggering events and coverage amount
- A triggering event occurs and its parameters meet or exceed those defined in the insurance agreement
- Payment is made days after swift confirmation of event parameters
Parametric insurance trends
As parametric insurance continues its rapid evolution, four key trends have emerged.
COVID-19 is driving interest in parametric insurance
Parametric insurance allows for much broader coverage of business interruptions due to non-physical damage, provided the event is measurable, such as a specific quantity of infections during a pandemic. During such a catastrophic loss, policyholders also have an immediate need for cash. Parametric insurance ensures they get their payout quickly, which could mean the difference between the survival and demise of their businesses, especially if they are running an SME.
Record payout times
Working with technology and data, progressive insurers are eliminating the need for loss assessment. This allows them to reduce the time between the occurrence of a trigger event and execution of payout to a few days, instead of several weeks or months, which is the case with traditional insurance.
IoT integration & sensor data
Thanks to the rapid rise of IoT and data capture, insurers have more opportunities to create parameters that are proxies to underlying risk.
Public authorities and agencies are common data sources. Usage of IoT sensor data is more complicated, as it requires a broader technological framework and a number of other characteristics — including the potential of policyholders tampering with sensors to modify data — that insurers must take into account.
Blockchain & smart contracts
Distributed ledger technology can be used to power smart contracts (contracts that are automatically executed based on predetermined events happening). This is a natural use case for parametric insurance, which greatly increases efficiency and transparency while decreasing payout execution times.
Blockchain, a distributed immutable ledger, is streamlining dispute resolution, which currently costs the sector $9 billion a year.3
Parametric insurance value chain
The insurance value chain is embracing digital technology and verifiable data that accelerate transactions and add certainty, shoring up trust and improving the customer experience.
- Data provisioning
Reliable information, data, or indices published by agencies or data providers such as the USGS in the US or EMSC in Europe for seismic activity.
Measurements from IoT devices the customer owns (e.g. farm machinery sensors) or IoT devices provided by an insurer (e.g. water level sensors from FloodFlash in the UK).
- Data processing & modelling
Work with data collected from public and/or private sources to verify that a triggering event has occurred.
AIR Worldwide and RMS are popular options in the US.
- Payout decision
Upon confirmation that a triggering event has occurred, the insurer executes the payout based on predefined conditions.
Data provisioning & analytics
Parametric insurance requires data and analytics from public and/or private sources.
Public data sources
Public agencies and their respective parameters or indices include:
- US Geological Survey (USGS) — earthquake magnitude
- European-Mediterranean Seismological Centre (EMSC) — earthquake magnitude
- Singapore National Environment Agency (NEA) — Pollutant Standard Index (PSI)
- Hong Kong Observatory (HKO) — typhoon warning signals
- Japan Meteorological Agency (JMA) — seismic intensity
- Australian Bureau of Meteorology (BoM) — tropical cyclone category
Private data sources
Non-governmental organizations that provide data for parametric insurance policies include:
WeatherFlow specializes in collecting wind speed data in the US. They have 100+ wind stations that can withstand wind speeds of up to 225 kmph (140 mph). This durability ensures that WeatherFlow can capture data, as extreme weather conditions tend to break or blow away small privately owned IoT wind stations.
Perils is a small company that provides its clients with index data, loss reporting tools, and loss reporting agents. They publish a database for Europe, the UK, Australia, and Canada using data aggregated from insurance companies.
Data processing & modelling
Notable companies that process and model weather data from public and private sources include:
AIR Worldwide and RMS are leaders in providing catastrophe bonds (a type of insurance-linked security) and are very knowledgeable in creating well-designed parametric triggers. Parametric insurance providers use their data analysis and modelling to verify the occurrence of triggering events.
The Bosch IoT Suite features a broad range of solutions for parametric insurance providers and policyholders. For example, the Bosch IoT Remote Manager handles module connectivity, administration, control, and updates. This data then transfers to the Bosch IoT Cloud via a cellular network. Bosch IoT Insights stores the data and provides tools to process it.
Relayr is an IoT device provider that focuses primarily on the automotive, manufacturing, food, and energy sectors. Their key value offering harnesses pioneering IoT data analysis and AI-powered automation technology to ensure effective planning, implementation, and support. This allows for exclusive financing (migration from a CAPEX to an OPEX model) and risk-free insurance models. As the company has been acquired by Munich Re, Relayr also offers insurance products.
As outlined in the definition of parametric insurance, payouts occur upon confirmation of the occurrence of a triggering event. Natural catastrophes, cybersecurity breaches, and pandemics are just a few of the events this new form of insurance covers.
Swiss Re is one of the top two parametric solution providers, focusing primarily on weather and natural catastrophes. Coverage types include earthquake, wind, flood, hail, cyber, wildfire, and life. The company’s FLOW product offers parametric water level insurance to protect companies from damage caused by high or low river water levels in Europe.
Swiss Re also offers its POP STORM platform to SMEs, enabling them to get a quote within seconds; customers can also sell the STORM policy to their own client base. The insurer typically pays out within 21 to 30 days after a triggering event.
Munich Re is the second of the two leading parametric insurers, covering events such as earthquakes, extreme wind conditions, floods, hail, cyberattacks, terrorism, and wildfires; they also provide life and energy insurance. For example:
- For energy, Munich Re covers risks related to power generation with a focus on renewable energy.
- For agriculture, Munich Re uses an index based on average yields and vegetation data derived from satellite sensors.
The company recently released “One Cat”, a parametric solution covering cyclones (One Storm) and earthquakes (One Quake) for large corporations and financial institutions.
In the field of parametric insurance, Axa Climate is one of the most active insurers. Originally launched in 2017 as AXA Global Parametrics, the company’s main areas of focus are natural hazard and agricultural insurance. The company uses index data and IoT sensors as data sources. While coverage setup takes one to two months, payout occurs within a few days of AXA receiving data from trigger events.
Naturally, there’s no shortage of impressive startups innovating the insurance industry. Here are some of the more successful ventures.
Operating solely in the UK, FloodFlash achieved a record payout time of under 10 hours following a flood that triggered the parametric cover in 2021. Here’s how it works:
- The customer chooses a water depth and financial settlement amount to get a quote in 60 seconds
- Within 14 days, FloodFlash engineers install smart water level sensors on the customer’s property
- Once the sensors register the agreed upon water level, the event is triggered and FlashFlood initiates settlement payout
Primarily US-focused, Arbol Market is built on blockchain technology, with smart contracts that get activated automatically as soon as triggering events occur. Payout takes place within two weeks after an event, sometimes as soon as four days. Arbol Market offers the following coverage:
- Hospitality & travel
Blink does not sell their own insurance products; rather, they provide a platform and tools via API for established insurers. For instance, the company partnered with Allianz Partners to roll out the insurer’s post-pandemic travel insurance platform. Blink’s solutions include:
- Blink Travel — flight data
- Blink Climate — weather data
- Blink Energy — weather data for extreme temperatures; uses national grid data for power outages
Operating exclusively in the US, New Paradigm offers
- Hurricane PM — uses WeatherFlow’s data for wind speeds and RMS for data processing and modelling
- Shake and Pay — uses USGS ShakeMap as a data source and RMS for event reporting and processing
- Terrorism PM
- Flood PM (coming soon)
U+ can help you build parametric insurance projects
The U+ Method can efficiently and effectively lead the development, implementation, and improvement of innovations in any sector. To date, we have used this method to bring 80+ products to market, creating over $1 billion in value for Fortune 1000 companies, including businesses in the insurance industry. Our success stories in this space include an online insurance product for Société Générale and a complete stack revamp for Columbia Insurance Group.
Our four-step product development methodology focuses on executing the risky stages of product development before initiating large build–outs.
We conduct initial idea validation and market testing, during which we evaluate whether an idea satisfies the wants and needs of a specific market and target demographics.
When we find a market-verified value proposition, we define the product and determine ways of taking it to the market. During this stage, we build prototypes, run smoke tests (a software testing process that determines the stability of a software build), and evaluate launch channels and features.
Our developers and designers build a minimum viable product (MVP) as we simultaneously move to launch with early adopters.
When the MVP launch goes well, we scale up the product based on market feedback. This stage typically includes support for internal operational processes and product modifications based on early customer feedback.
Contact us to learn more about how U+ can drive your innovation projects to success.
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