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Parametric insurance: Covering the uninsured and underinsured

Insight Jan 10, 2023

If the past few years have taught us anything, it is how quickly things can change, whether due to a natural disaster, a pandemic, or war.

But insurers, despite their role as a stabilizing force in society, are just starting to realize that it’s time to rethink their strategies and priorities.

Take natural disasters for example. We see more and more severe weather events causing extensive damage to life and property. Yet, Swiss Re found that only $115 billion of the total $260 billion estimated economic loss was insured in 2022.

This and more other gaps between the insurance coverage that people need and what is currently available on the market indicate an opportunity for insurers to innovate and provide meaningful solutions to the uninsured and underinsured against emerging risks.

It also shows that insurers who offer new and creative insurance products to bridge the gaps can not only satisfy customers but also set themselves apart from the competition. Looking for inspiration? Parametric insurance products are ones that are worth exploring.

What is parametric insurance?

Unlike traditional insurance, parametric insurance is an index-based solution where once a specific event occurs, the payment process is automatically triggered. The amount payable is also predefined, so there is no actual need for on-the-ground loss adjustment.

These days, both large insurers and start-ups are coming up with innovative products that use parametric triggers to address consumers’ diverse needs, such as:

Parametric insurance complementing existing offerings

A complement to traditional insurance, parametric insurance can offer several advantages for both the insurer and the insured. Some of the more significant benefits include:

  • Faster pay-outs

    In almost all events, parametric insurance can issue instant pay-outs because it eliminates the need for a tedious loss adjustment. It enables policyholders to focus on recovery and resume business as usual without the added distress of navigating a complex claims process.

    Though pay-out can sometimes be higher or lower than the actual loss (i.e., basis risk), insurers can mitigate this risk through accurate modeling – product design, wording, communication, and careful consideration of alternative scenarios.
  • Improved insurability

    Parametric insurance comes with a predefined maximum pay-out amount, which allows insurers to cover risks that were previously uninsurable at affordable premiums.

    This is not the case with indemnity insurance, where there is no maximum limit on the number of damages that can be claimed, meaning pay-outs can quickly get expensive for insurers.
  • Customer-centricity

    Simplicity and transparency are the two major selling points of parametric policies. These policies are typically easier for the insured to understand and less complex than their traditional counterparts. Thus, there is less room for disputes or uncertainty.

    In addition, parametric insurance eliminates the need for excessive paperwork and claims investigations, resulting in a seamless customer experience. Another aspect that works in its favor is the absence of fine print, which translates to a higher level of customer satisfaction.
  • Lower premiums

    When compared to traditional insurance products, parametric policies are usually cheaper. This is because they don’t require extensive underwriting and risk assessments, which can significantly reduce the cost of premiums.

    In contrast, with indemnity insurance, insurers must rely on actuarial data and other methods to estimate the severity of potential losses, leading to higher costs and higher premiums.
  • Flexible coverage

    Since parametric policies are often tailor-made for customers after taking into consideration each individual’s risk profile, they offer a higher level of policy customization.

    Due to this flexibility, they can meet unique customer needs and address specific risks, making it easy for customers to get the right amount of insurance without having to pay too much or too little.

More innovation to come from parametric insurance

With the latest advancements in risk modeling and technology, it won’t be long before insurers are in a position to better understand and price risks.

Taking advantage of the growing satellite data and other forms of remote sensing will further allow insurers to provide near real-time protection against unpredictable events.

Overall, the growth possibilities point to a future where parametric insurance will be more widely avai