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The Rise of Parametric Insurance: Paying Out Based on Data, Not Damage
Data Analytics Insurance

The Rise of Parametric Insurance: Paying Out Based on Data, Not Damage

By Rajarshi August 27, 2024 - 82 views

Use cases for data analytics in insurance have evolved considerably in recent years. One of the biggest such innovations is parametric insurance that is steadily rising in importance, with the increasing unpredictability of the world and environment today. Instech reports have already highlighted how parametric solutions saw record growth in 2022 and the trend is set to continue over this decade as well.

What is Parametric Insurance?

Often labeled as climate risk insurance or disaster insurance, parametric insurance can be classified as the following:

  • A form of insurance that offers prefixed payouts based on predetermined parameters/events, irrespective of actual losses/damages.
  • For example, consider home insurance coverage that is dependent on a few parameters. These may include specific precipitation in liters, wind speeds, and so on. This will trigger payouts to policyholders, independent of the actual damage that the home witnesses in any calamity.
  • Even though the home may remain intact, the insured person will receive this amount. At the same time, damages may occur despite the parameters being lower than those agreed upon. In this case, payouts will not be triggered, even though the policyholder has to bear the costs of these damages.
  • Traditional insurance calculates compensation based on actual losses/damages, while parametric insurance does not.
  • There are multiple applications of the model, including flight delays beyond a specific time, cyber-attacks, earthquakes of particular magnitudes, and poor harvests of crops.

Why Parametric Insurance is Beneficial?

Insurtech players have already started realising the value of parametric insurance solutions, particularly for helping communities build financial resilience in the light of unpredictable and volatile climate risks. Some of the key benefits include the following:

  • Higher agility, speed, and predictability for claim resolution.
  • Technology and data-based automatic claims resolution.
  • Fixed payouts triggered based on contracts, without time and resources being spent on determining these amounts.
  • Lesser chances of claim challenges by policyholders, thereby saving time and hassles for insurance companies.
  • Parametric solutions are making it possible to offer insurance coverage for risks that were deemed uninsurable in the past.
  • It can enhance insurance access for communities and individuals hampered by the unavailability/inaccessibility of conventional insurance or stuck due to its higher costs.
  • Vulnerable communities are now obtaining much-needed coverage for diverse risks ranging from earthquakes to drought.
  • There are also lower chances of fraud, seeing as the events that take place are not subjective, but fully objective and there are lesser chances of fraudulent claims.

Are There Any Disadvantages?

While the advantages of parametric insurance clearly outweigh the disadvantages, there are still a few moot points in this case.

  • Differences between compensation paid to customers and actual incurred damages in some cases.
  • Clients may incorrectly estimate the magnitude of damage-causing events while signing contracts. This may lead to situations where they incur losses, but do not get payouts due to certain parameters not being of a certain magnitude.
  • Insurance companies may also lose out due to policyholders getting payouts after specific thresholds are triggered, without incurring any actual damages.
  • There is thus a need to carefully and intricately tailor policies which combine parameter-based payouts with conventional claims verification, compensation, and notifications.
  • Yet, hybrid policies based on this concept will have limited benefits in terms of scale, agility, and fast claims processing.

How It All Stacks Up

Parametric insurance is an innovative product that is well-positioned to take-off in the current global scenario, despite its potential drawbacks. Technology will play a vital role in data-based payouts in the future. This will include real-time tracking from ground-based sensors and satellite/radar imagery and data. The aim of the insurance product in this case is to minimise risks as much as possible based on advanced data and technological prowess.

In fact, it can well transform into a more effective and robust climate risk insurance model, thereby incorporating the costs of climate change in a better way. With the certainty of these products, a higher portion of premiums that buyers spend on coverage come back to them as claims, instead of being spent through disputes and frictional expenditure. Parametric insurance is also customisable to various industries and corporate clients, since it is not concerned about the type of asset, rather wider financial losses due to triggering events. Clients in the corporate sector can thus tackle the bigger financial impact on operations in case of climate events, including vendors, suppliers, customers, and logistics. IoT and other new technologies will keep powering parametric solutions, with warning systems that can inform customers about potential risks. This will help them take preventive measures in advance. LLMs or large language models are also positively impacting the sector and will completely change underwriting in the future. They will process vast datasets swiftly, including claims history and historical occurrences, thereby enabling underwriters to predict future claims more efficiently. So, to sign off, it can be said that parametric insurance should be around in the coming decade and even beyond. With more insurance companies, underwriters, customers, and brokers recognising it as a good solution for risk transfer, there will be more evolution into secondary complexities and events like floods, hail, thunderstorms, wildfires, and more. With data being leveraged comprehensively for pricing, this form of insurance will make underwriting easier and lower the time to quote and finalise policies or even settle claims. This will help insurance companies save more time and money, which will prove hugely beneficial in the long run.

FAQs

1. What is Parametric Insurance and How Does It Differ from Traditional Insurance?

Parametric insurance is a form of insurance where payouts are triggered based on certain pre-determined thresholds/parameters. It is different from traditional insurance, since it is not concerned with the actual loss/damage.

2. How Does Parametric Insurance Work?

In case of any event/disaster that triggers any specific thresholds/parameters like wind speed, earthquakes of a certain magnitude, and so on, pre-fixed payouts will be given to policyholders, irrespective of their actual losses and whether they have suffered losses or not. Claims processing will be near-automatic due to pre-fixed agreements.

3. What Are the Benefits of Parametric Insurance for Policyholders?

Communities and people without access to conventional insurance can benefit from higher financial resilience against climate change with parametric insurance. It enables swift payouts and more agile operations, while saving time and resources. It also lowers the chances of disputes with policyholders and fraudulent claims.

4. What Types of Events Are Covered by Parametric Insurance Policies?

Parametric insurance policies can cover a wide range of events including earthquakes, poor crop yields/harvests, natural disasters like hurricanes and cyclones, and so on.

5. How is the Payout Determined in Parametric Insurance?

The payouts in parametric insurance are determined based on whether specific thresholds have been triggered in the case of any event. There is no consideration for the actual loss of the policyholder. If these parameters are triggered, then payouts are released to policyholders and are pre-fixed amounts. These amounts are estimated by policyholders in most cases, depending on their calculations of the potential financial cost of damages due to varied natural disasters and other such events.

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