How to Define Parametric Insurance
Parametric insurance is where you buy a defined amount of protection which will pay out when defined terms are met. Meaning, when the terms or event has occurred, a predetermined lump sum payout will then follow.
This type of insurance is not traditional. In traditional insurance, such as car insurance, you’re being covered for the cost of any damages. An assessor will evaluate the cost of the damage and your payout will be based on that specific damage. However, in parametric insurance, you are paid out when a specific event occurs, such as a flood, and the level of damage does not matter.
Let’s define the term parameter before we get started so we are all on the same page. A parameter is a framework or boundary that defines the scope of a process or activity. It is a constant, a set of facts or a fixed limit that determines how something can or must be done.
How does it work?
There is roughly a 3-stage process that happens, here is a brief overview of them. And let’s use some emoji’s to help keep things fresh 😂
Selecting cover ☂️ – You choose what it is you want cover for. This is generally something that is specifically covered by other types of insurance. You then decide what value you place on that triggering event, such as a flood on your crops.
The agreement 🤝 – You and the insurer will then come together to work out the specifics of what parameters or variables need to be met. This could be a category of hurricane, a specific flood depth or any other type of measure. The point of this part of the cover is that it’s black and white, and something that can be easily measured.
The settlement 💷 – When your agreed parameters have been met, (a hurricane category 2 for example) the insurer will payout. As long as there is evidence that the parameters have been met, there will be no issues.
What are the benefits of parametric insurance?
Quick payout 🏦 – Take a flood, for example. If you have a property that has been flooded, then you would normally have to wait for the water to recede before you can even look at the damage. Once it has, then you need an assessor to come around and work out the value of all the damage to determine your payout. With parametric insurance, as soon as that parameter is hit (let’s say a certain flood depth) then the wheels will instantly be in motion to get your insurance payout. This can help save you a lot of time.
More specific coverage ✍️ – You’re insuring against the risk of something happening with a specific sum, rather than insuring yourself for the damage that has been caused. Which means that you are more likely to get an affordable premium. If you were unable to get specific cover for a specific risk, then parametric insurance could be a great way of protecting yourself.
Transparency 🪟 – With traditional forms of insurance it's going to be up to a loss adjuster to determine the value of your claim. This can involve giving property and its contents a value that may be subjective. With parametric insurance, the payout is already going to be agreed upon, so it can reduce some stress knowing exactly what you’re getting.
Control 🕹️ – With traditional insurance it will often be stipulated what the money you get can be used for. However, with parametric, the payout you receive isn’t affected by the amount of damage, so you will have a lot more control over what you can use it for.
Often with parametric insurance, the insurer doesn’t have to worry about lengthy claims processes, legal costs and loss adjustors, so the lower cost for them can often be reflected in lower premiums. However, this often means the payouts will be lower as well.
So, if you think there is a specific risk that your regular insurance is not going to be able to cover, then it can be a great option.