Parametric Insurance Advisory

Parametric insurance is a type of insurance that pays out a pre-agreed amount of money in the event of a specific, measurable event occurring. Unlike traditional insurance policies, which require a loss to be verified before any payout is made, parametric insurance pays out automatically once certain predetermined conditions are met.

Parametric insurance can be used to cover a wide range of events, from natural disasters such as earthquakes and hurricanes to non-physical events such as business interruption due to a cyber-attack. Essentially, any measurable event can be covered by a parametric insurance policy.

Traditional insurance policies require a loss to occur before any payout is made, and the payout is typically based on the value of the loss. Parametric insurance, on the other hand, pays out a predetermined amount based on the occurrence of a specific event, regardless of the actual value of the loss.

Parametric insurance can be advantageous in situations where traditional insurance may not be feasible or cost-effective. Because parametric insurance payouts are based on objective, measurable events, the claims process can be faster and simpler than with traditional insurance. Additionally, parametric insurance can provide coverage for risks that may be difficult to insure in other ways.

One potential disadvantage of parametric insurance is that the payout may not always align with the actual losses incurred (known as ‘basis risk’). For example, if a business experiences a loss due to a weather event, the payout from a parametric insurance policy may not align with the actual cost of the damage. Additionally, parametric insurance policies may be more expensive than traditional insurance in some cases.

Parametric insurance may not be suitable for all types of risks. Events that are difficult to measure or predict might not be eligible for parametric insurance coverage. Additionally, the payouts from a parametric insurance policy may not fully cover all losses incurred by the insured, which could be a drawback for some businesses and individuals.

Generally speaking, parametric solutions can be executed as an insurance contract or as a derivative, depending on the preference and needs of the client. It always depends on a country’s regulatory and legal framework, but usually the main difference is that an insurance contract requires an ‘insurable interest’ and a ‘proof of loss’. If executed as an insurance contract, the policy follows the same accounting rules and principles as any other insurance contract.

Parametric solutions can be structured to cover various types of events beyond just natural catastrophes (Nat Cat). While parametric solutions are particularly well-suited for Nat Cat risks due to the ability to quickly and objectively measure the occurrence and severity of a triggering event, they can also be designed to cover other risks that have measurable indices or triggers.

For example, parametric solutions can be structured to cover events such as political risk events, commodity price fluctuations, energy price volatility and other types of risks that have well-defined triggers or indices that are observable. In all cases, the key is to accurately identify a trigger that will appropriately reflect the underlying value of the loss that needs to be compensated.

By leveraging parametric solutions to cover non-Nat Cat events, businesses and insurance companies can gain access to alternative risk transfer strategies that provide faster payouts and more predictable coverage than traditional insurance products.