Parametric insurance, or index-based insurance, is a non-traditional form of insurance primarily used in agriculture. The concept of parametric insurance is focused on funding victims of disasters, and is a means to provide post disaster funds for emerging and otherwise difficult to insure risks. This type of insurance often attempts to cover the damages of climate extremes such as hurricanes, earthquakes, floods, etc. Unlike traditional insurance, instead of solely indemnifying for the actual loss incurred, parametric insurance covers the probability of a predefined event, or trigger event, happening and pays out according to a predefined payout plan.
Trigger events are defined by the nature of the parametric policy in place and can include environmental triggers such as wind speed and rainfall measurements, business-related triggers such as foot traffic, and more. In other words, a parametric insurance plan has the potential to cover not only the property of the insured, but also the infrastructure critical to client accessibility.
Furthermore, parametric insurance plans can be structured to pay out a percentage of a predefined amount depending on the severity of the trigger. For example, such an insurance plan could specify that the insured may receive 50%, 75%, or 100% for a category 3, 4, or 5 hurricane, respectively.
The bounds of the area covered by a parametric insurance plan can be defined by a “point of interest”. A point of interest is a geographical coordinate on a map that acts as the central location of the covered area. In this case, a trigger event occurring in a defined radius around the insured point of interest may lead to a payout.
Traditional insurance includes payment triggered by actual loss of or damage to a physical asset. Parametric insurance payments are triggered by an event exceeding a parametric threshold. For example, the state of Quintana Roo in Mexico receives 40% of their maximum parametric payout when winds speeds reach anywhere from 100-129 knots in order to cover damages done to the coral reef. As a result of this payout structure, traditional insurance coverage can be complex and time-consuming as each claim must be investigated and verified before any payout can be made. On the other hand, parametric insurance plans involve limited, clearly-defined, situational coverage that often covers damages from easy to verify, large-scale weather events. Thus, parametric insurance payouts are made much faster than traditional insurance payouts.
Furthermore, parametric insurance plans are completely customized to fit the situation of the insured while traditional insurance contracts are predominantly standardized and leave little room for flexibility. In addition, traditional insurance often requires annual renewal while parametric insurance may be offered through a one year or multi-year agreement.
However, since parametric insurance coverage is detached from any actual loss or damages, there is no guarantee that payouts will cover the full extent of the damage that has occurred.
