Parametric Insurance: A New Spin on an Old Product

Parametric Insurance: A New Spin on an Old Product

During this year’s Pinnacle University (Pinnacle U) event, we presented an overview of parametric insurance. Unlike traditional insurance coverage, parametric insurance is not an indemnification product. Instead, it determines a benefit payable in advance of the policy purchase by estimating the loss as accurately as possible, subject to certain conditions being satisfied. The cost of the policy is based on a pre-determined trigger. Examples might include maximum sustained wind speed for hurricane coverage or earthquake magnitude as measured by the Richter scale.

An insurer may prefer to issue parametric over traditional insurance products because of significant claims-processing savings. With a pre-determined trigger and indemnity cost, there is no need for claims adjusting. Further, there is no need to establish a case reserve for reported claims. The insurer will need to accrue for unpaid claims liabilities for events that have occurred but for which complete information about the parametric triggers is not yet known. However, once those triggers are verified, the value of claims is known immediately.

Parametric insurance is superior to traditional coverage because the insured is paid more quickly. Insureds also have wider access to coverage for well-defined risks. A significant drawback to parametric insurance is evident when insureds may incur more loss than the benefit provided. Moreover, some insureds may receive benefits without sustaining any real losses.

Experts foresee parametric insurance taking a larger role in insuring catastrophic events as there would be no need for insurers to dispatch large teams of claims adjusters to assess damages or verify coverage. With catastrophic events resulting in thousands of claims, there is considerable time and expense associated with adjusting them. Parametric insurance eliminates the need for claims adjusters and requires only verification of the triggering event for claim payment. 

Parametric coverage should also enable geographic regions currently lacking well-developed insurance programs to access insurance benefits. In Africa, for example, individual loss assessment can be very expensive in underserved areas for perils such as drought. In such regions, the loss area requiring assessment, like a rural farm, often has very remote access and the nearest claims adjuster can be thousands of miles away. The biggest challenge currently preventing parametric insurance implementation in these zones is the lack of technology or independent organizations to verify whether a trigger event has occurred. Once such organizations and/or technologies exist to assess the coverage triggers, parametric insurance is likely to offer monetary protection to areas which desperately need it. 

There is talk of decentralizing insurance using a parametric product. In general, a decentralized insurance product removes the need for an insurer to underwrite and process claims. To do this, the decentralized parametric insurance product would utilize blockchain technology.

In order to understand how it would work, imagine a blockchain with each block operating as a ledger. A first block would store data (policy information) and some general information about the location of the block in the chain, then a smart contract would be coded into the block. The smart contract would connect to a data provider and check to see if a trigger event has occurred and whether a payout is warranted. If the data indicates a trigger event meets the threshold, the smart contract would automatically execute itself according to the coded terms. It would then proceed through a peer-to-peer (P2P) network to verify everything is in order. Utilizing blockchain and smart contacts for parametric insurance can also provide a level of transparency and trust to the insured. 

With the ever-increasing amount of available data, it is easy to imagine parametric insurance assuming a larger role in the insurance world. With fewer expenses incurred and the ability to provide benefits to areas heretofore unserved, and for coverages previously deemed uninsurable or unprofitable, parametric insurance may one day rival traditional insurance in certain sectors.

 

Linda Der is an Actuarial Analyst with Pinnacle Actuarial Resources, Inc. in the Atlanta, Georgia office. She holds a Bachelor of Science degree in International Economics and Japanese from the Georgia Institute of Technology in Atlanta. Ms. Der began work in the property/casualty insurance industry in 2013 as a worker’s compensation claims adjuster and joined Pinnacle in November 2016. She is actively pursuing membership in the Casualty Actuarial Society through the examination process.

James Ridgeway is an Actuarial Analyst with Pinnacle Actuarial Resources, Inc. in the Bloomington, Illinois office. He holds Bachelor of Arts degrees in Economics and Actuarial Science from the University of Wisconsin Milwaukee. James has experience in assignments involving Loss Reserving, Funding Studies, Loss Cost Projections and Group Captives. He is actively pursuing membership in the Casualty Actuarial Society (CAS) through the examination process.
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