Parametric Coverage: Fast Payouts for Hard-to-Cover Risks
Published on May 05, 2023costerobadmin
Imagine these scenarios …
- A hurricane rips off the roof of a chemical factory, compromising the materials and forcing the factory to close for the foreseeable future.
- Wildfire devastates a community, causing significant damage to a powerplant. A renewable energy company requires 250 sunny days per year to meet business goals and avoid additional costs. These are all scenarios in which businesses may have immediate cash-flow needs that aren’t addressed quickly enough by the traditional insurance claims process.
For businesses dealing with lost revenue and urgent repair needs, these delays can pose a serious threat. If coverage excludes some of the losses, the situation is even more dire. Parametric insurance provides an alternative solution, delivering fast relief to businesses.
What Is Parametric Insurance?
Unlike traditional indemnity-based cover (which pays claims based on the assessed magnitude of the loss), parametric insurance pays a set amount following the occurrence of a specific event, based on the magnitude of that event. The parametric method simplifies the claims process, removing the need for lengthy investigations and costly legal disputes and facilitating a fast claims payout to policyholders when they need it most.
In the hurricane example above, the payout may trigger as soon as the track of the hurricane is reported by the National Weather Service to have come within an agreed distance from the insured property.
What Can Parametric Insurance Cover?
Parametric policies typically provide coverage for a single weather or natural catastrophe peril, such as tornadoes, hurricanes, wildfire, or earthquakes. However, coverage is also available for non-damage BI scenarios such as drought. In fact, parametric covers are available for almost any type of event which can be linked to an independently verifiable, third-party data source. Parametric triggers may include wind speed, rainfall, snowfall, earthquakes, wildfire, hail, days of sunshine, temperature and agriculture yield to name a few.
Consider the following scenarios:
- A car dealership can’t find coverage for damage due to hail, despite having to store the majority of their stock in hail-exposed outdoor parking lots. They choose to cover a portion of their stock value with a parametric hail policy.
- A ski resort needs a certain amount of snow to open for business. The resort buys a parametric insurance policy that pays if X inches of snowfall does not occur by a certain date.
- A wheat mill depends on a large crop yield. If the crop yield is lower than expected, the government may pay the wheat farmers a subsidy, but other businesses like mills that support the agricultural industry may not qualify. The mill takes out a parametric insurance policy that triggers if the crop yield is below a threshold.
Other triggers are also possible, depending on the needs of the policyholder. For example, a company could explore parametric coverage to protect against cyber downtime, acts of terrorism, active shooter scenarios, or travel cancellations. Coverage is possible for nearly any large exposure.
Who Needs Parametric Insurance?
Parametric insurance is suitable for businesses with significant risks that traditional insurance excludes or may not adequately cover. The typical premium threshold is $100,000 for any single opportunity.
After a major loss, business interruption can be as costly as the property damage itself. Businesses need robust coverage for these losses. However, securing adequate coverage can be challenging, especially for businesses with risks that insurers are reluctant to take on. As a result, businesses may face exclusions and retentions that reduce the amount of coverage available. Parametric insurance provides an alternative way of controlling risk.
For example, let’s say a company has a $10 million limit with a $1 million self-insured retention. The company does not want to take on $1 million of the risk, but the large retention is necessary to secure coverage, due to the nature of the business and the hurricane-exposed location. The company can purchase a parametric insurance policy that covers hurricanes to protect its own $1 million exposure.
More complex examples may involve working with an insurer, reinsurer or captive that requires a certain amount of liquidity to maintain its financial rating. A parametric policy provides a fast payment of funds following a catastrophic event that may threaten the strength of their balance sheet.
Parametric insurance may not make financial sense for businesses that are able to secure affordable traditional insurance to cover their risks adequately. However, for organizations with complex risks that are more challenging to insure, parametric coverage offers a useful alternative. A few industries that may benefit from parametric insurance include construction, energy, and agriculture.
How Does the Underwriting Process Work for Parametric Insurance?
Although parametric insurance streamlines the claims process, the quoting process may take longer than indemnity insurance. Businesses and their brokers should start the process well in advance of when they need coverage.
Although terms are generally open for 30 days, because of the limited number of carriers offering coverage for certain perils in a geographic area, quoted terms may be withdrawn with short notice when they hit their coverage limit. For example, if you need wildfire coverage for your vineyard but all the neighbouring wineries have already purchased coverage, the carrier may have reached its aggregate limit and be unwilling to provide any more coverage in the area. Additionally, rates may increase as the season approaches. For these reasons, it’s important to begin the process as early as possible.
Businesses interested in parametric coverage need to supply the necessary information, including the following:
- Name of the Insured
- Risk Location
- Total Value of the Asset/Portfolio
- Limit to Be Insured under the Parametric Policy
- Target/Budget Premium
- Loss History
- Confirmation of Acceptability by Client/Lender
What Else Should Businesses Know About Parametric Insurance?
The initial price of parametric insurance may be quite high depending on the peril and the threshold when payments start to become due. However, it’s possible to tailor the pay-out structure to fit the policyholder’s budget, and there are significant savings to be made in the claims process.
Even if the exposure or scenario you need insure is not mentioned above, coverage may be possible. The options are endless. Call us to collaborate.