Your Guide To Parametric Insurance
Exploring Trends in InsurTech
By Adam Gaertner and Jonathan Schoelkopf
Overview
Parametric insurance, otherwise known as index-based insurance, is a type of insurance that offers a unique approach to risk management. Instead of traditional insurance policies, where the payout is dependent on the actual loss suffered by the policyholder, parametric insurance offers a predetermined payout based on specific pre-agreed-upon parameters. These parameters could be related to weather, such as rainfall exceeding a particular amount, wind speed exceeding a certain limit, or temperature rising beyond a specific level. It could also be related to financial or economic indices, such as the performance of a particular market or the value of a specific currency.
The payout mechanism for parametric insurance operates like an if/then contract. When the agreed-upon parameters are met or exceeded, the coverage is automatically triggered, and the policyholder receives a payout. The amount of the payout is determined by a set formula that is agreed upon at the outset of the policy.
One of the key advantages of parametric insurance is that it eliminates the need for a traditional loss-adjustment process. This process can be slow, expensive, and often results in disputes between the insurer and the policyholder. With parametric insurance, the payout is based on objective and independently verifiable data, which reduces the potential for disputes and makes the claims process faster and more efficient.
Parametric insurance is particularly useful for situations where traditional insurance policies are not suitable. For example, weather-related events such as hurricanes, floods, and droughts can cause significant damage and loss, but traditional insurance policies may not cover these risks adequately. Parametric insurance provides a way to cover these risks by using specific weather-related parameters as triggers for coverage.
In addition to weather-related risks, parametric insurance can also be used to cover other types of risks such as cyber threats, power outages, flight delays, and other similar situations. By using objective and independently verifiable data to trigger coverage and determine payouts, parametric insurance offers a more efficient and effective way to manage risk.
Strengths and Relevance
Parametric insurance is becoming increasingly prevalent in recent years, as evidenced by the following trends and statistics:
The global market for parametric insurance is expected to grow from $2.6 billion in 2020 to $6.9 billion by 2025, at a CAGR of 21.7% during the forecast period.
Parametric insurance is gaining traction in the renewable energy industry, where it is used to mitigate weather-related risks such as wind, solar radiation, and precipitation.
The use of parametric insurance is expanding beyond natural catastrophes to cover other risks such as cyber threats, terrorism, and pandemics.
The number of parametric insurance products available in the market is increasing, with new offerings tailored to specific industries and sectors, such as agriculture, transportation, and hospitality
The use of parametric insurance is expected to increase in emerging markets, where traditional insurance products may be limited or unavailable, and where there is a need to provide affordable and accessible insurance solutions to low-income populations.
Overall, the trend towards parametric insurance is driven by its ability to provide fast and efficient payouts based on objective and verifiable data, reducing the cost and complexity associated with traditional insurance products. As a result, more insurers and policyholders are adopting parametric insurance as a means of managing risks and protecting against potential losses.
Case Study - Arbol (Link: Arbol | The future of climate risk management)
Arbol is a FinTech company that helps businesses manage and reduce their exposure to climate risks. They offer parametric coverage solutions that pay out based on objective measurable data triggers. Arbol has built a solution that includes a vast climate data infrastructure via NASA, efficient product development, and automated pricing using algorithmic underwriting. In addition to this they use blockchain technology to improve operational efficiency and attract non-insurance sources of capital. By combining all these factors, Arbol provides scale, transparency, and efficiency in parametric coverage, which ultimately sets them apart from the traditional reinsurers that currently dominate the climate risk insurance space.
The way they leverage parametric insurance sets them apart from the competition because of the variety of environmental-based triggers they use. The problem that they are solving is the severe lack of innovative solutions to hedge environmental risks as climate change continues to alter our world. The main risk they insure, and how they started off, was from insuring crop yields. They utilize data from NASA like historical yields, and compare it with county averages to ultimately trigger a payout if they are below it. The main strength of their product doesn’t necessarily lie in insuring the farmers themselves, but rather by letting it trickle down the supply chain. One example is with local cotton gins in Texas, if the crop yields in that area are lower, the farmers are covered by federal crop insurance, however the cotton gin who then has to pay twice as much for their cotton is not. Arbol continues to innovate in the space, and is now one of the prominent players in the parametric insurance space.
Case Study - Centinel (Link: Centinel (yourcentinel.com))
Centinel is a technology company that specializes in providing a digital platform for parametric insurance policy management and claims processing. Their platform leverages the power of parametric insurance by using independently verifiable data to trigger coverage and payout mechanisms based on predefined parameters, such as weather-related events, cyber threats, and power outages. Centinel's AI-powered claims processing system automates the claims handling process, reducing the time and cost associated with traditional claims management for parametric insurance. Their goal is to make the parametric insurance experience seamless and efficient for policyholders and insurers alike.
Case Study - TerraCover (Link: TerraCover)
Terra Cover is a geospatial technology company that uses machine learning and earth observation data to provide geospatial analytics for water accounting and insurance. They were founded in January 2020, and are under the umbrella of the University of Minnesota, where their research began. Terra Cover received a grant from the National Science Foundation, which allowed them to continue their R&D work. Currently, they are focused on commercializing their research in the insurance industry, particularly in residential flood insurance. Their digital marketing solution will be sold to businesses, and provides support to insurance providers and brokers through geospatial analytics of flood data. Terra Cover shares their resources with strategic partners, generating leads and finding potential customers for other insurance companies. They provide policies through outside insurance companies and as policies are sold, they receive a revenue share. Terra Cover's ultimate product will be a digital summary of flood risk for consumers, displayed on their phone. The company has a huge potential market, as flood risk assessment is historically an underserved area across insurance.
Conclusion:
It is clear that parametric insurance is gaining popularity and traction as a more efficient and effective alternative to most traditional insurance products. With the ability to provide fast and objective payouts based on measurable data, parametric insurance will continue to rise in popularity in various industries. The growth of the global parametric insurance market will continue driven by the need for affordable and accessible insurance solutions in emerging markets, as well as the increasing demand for climate risk management. Innovative companies like Arbol, Centinel, and TerraCover are leveraging this technology to provide scalable and transparent parametric insurance solutions that address the evolving needs of policyholders and insurers. As parametric insurance continues to evolve and expand its reach, it is poised to become an integral part of the insurance industry's future.