Parametric insurance

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Parametric insurance (also called index-based insurance) is a non-traditional insurance product that offers pre-specified payouts based upon a trigger event. [1] Trigger events depend on the nature of the parametric policy and can include environmental triggers such as wind speed and rainfall measurements, business-related triggers such as foot traffic, [2] and more. Examples of current parametric products include the Caribbean Catastrophe Risk Insurance Facility (CCRIF), the African Risk Capacity (ARC), and the protection of coral reefs in the state of Quintana Roo in Mexico.

Contents

Parametric insurance policies have most frequently been implemented in developing economies, oftentimes for agriculture insurance. In the US, there are proposals to implement parametric policies more often, specifically in the case of flood insurance through the National Flood Insurance Program. [3]

Comparison to traditional indemnity insurance

Traditional indemnity insurance is structured so that after an event that leads to a loss, such as a fire, flood, storm, or car accident, the insurer reimburses the insured for the total value of the loss, assuming no limits and deductibles are included in the insurance policy. To quantify loss, a representative from the insurance company assesses the damage. In a parametric insurance policy, insurance companies need to verify that the loss event exceeded the trigger event(s) specified in the policy. For weather-based parameters, this involves researching measurements from trusted third-party weather services or collecting sensor and satellite data to verify the magnitude of the weather event. Once the magnitude of the trigger is verified and "proof-of-loss" is obtained, the insurer disseminates the payout specified in the policy for the corresponding trigger event(s) to the insured.

The main benefit of parametric insurance policies is that they offer faster payouts than traditional insurance based on the nature of the trigger event. [1] Because it is quick to verify if the trigger event passed the threshold specified in the policy, parametric policies can payout quickly. These quick payouts are especially beneficial for the liquidity to successfully recover after a disaster strikes. In addition, parametric insurance is suited for hard-to-model, low-frequency but high-intensity losses as in catastrophic perils, weather-related risks in agriculture or other economic activities, and risks sought to be covered without sufficient history of losses captured as insurance-readable data. Finally, parametric insurance may reduce transaction costs involved in writing and administering insurance policies because there is less need for actual loss assessment for payment of claims or underwriting rating requirements to determine the premium based on liabilities and extent of risk sharing.

The main drawback of parametric insurance policies is that they often do not cover the full basis risk of the insured. Policies are based on parameters and, therefore, do not always cover the full damage that occurs.

Examples

Coral Reefs in Quintana Roo, Mexico

Part of the Mesoamerican Reef (MAR) is located off the coast of the state of Quintana Roo in Mexico, where Cancún is located. The reef has experienced degradation from pollution, storm damage, rising ocean temperatures, and increasing tourist activities. Recent analysis indicated that the reef prevents $42 million in damage to buildings and $20.8 million in damage to hotels annually. [4] In response, Quintana Roo created the Coastal Management Trust Fund to purchase a parametric insurance policy for protecting and restoring the reef. [5] The parametric policy has an annual maximum payout of $3.8 million and is triggered by wind speed. [6] The payout changes based on the wind speed in the manner below:

Partners of the Quintana Roo government include the Nature Conservancy, the Cancún and Puerto Morelos Hotel Owners’ Association, CONANP, Mexican Universities and insurance industry representatives. [7]

The insurance policy was triggered during Hurricane Delta in October 2020, for which the Coastal Management Trust Fund received $850,000. [8]

Caribbean Catastrophe Risk Insurance Facility (CCRIF)

CCRIF is an insurance company established in 2007 that allows Caribbean and Central American Countries to purchase parametric insurance products for weather catastrophes. [9] By pooling their risks together, each participating country is able to purchase insurance for significantly less than if they had gone through the private market.

Pacific Catastrophe Risk Insurance Company (PCRIC)

In the aftermath of Cyclone Harold (2020), the government of Tonga received a US $4.5 million payout from the Pacific Catastrophe Risk Insurance Company (PCRIC) based on its insurance cover against tropical cyclones, the largest payment in the company’s history. These funds provided the government with much needed rapid-response financing to support disaster-relief efforts at a crucial time with Governments around the world also grappling with the impacts of COVID-19.

Tonga is one of the Pacific Island countries that purchased catastrophe risk insurance from PCRIC – a regional catastrophe insurance platform that offers governments insurance cover against climate and seismic hazards, currently tropical cyclones and earthquake/tsunamis. PCRIC policies are designed to payout quickly after a triggering event to provide immediate access to liquidity for disaster response. A representative of the Government of Tonga welcomed confirmation of the payment: “These funds will enhance our ability to respond to the needs of our communities impacted by Cyclone Harold and already dealing with the impacts of the COVID-19 global pandemic” said Balwyn Fa’otusia, CEO for the Tonga Ministry of Finance “in these challenging times the value of these products has been shown in supporting our wider strategy to financing natural disaster responses.”

Cyclone Harold reached its peak intensity as a Category 5 cyclone as it tore a path across the Solomon Islands, Vanuatu, Fiji and Tonga, causing widespread destruction across the region. The cyclone passed within 100km of Tongatapu, Tonga’s main island, with significant storm surge coinciding with king tides, which caused wide spread damage around the coastline. [10]

Northern Territory, Australia Parametric Cyclone Cover

in November 2021, Lloyd's backed Redicova implemented a parametric cover that utilises a payout per unit of cover with discreet units redeemable for $1,000 in the event of a loss. If a property is directly in the path of a cyclone, the payout is $1,000, while an affected property within a 5km buffer zone would see a payout of $300 per unit purchased. This allows rapid payout with no assessment of loss.

Parametric Hail Cover for Dealerships in Australia

As climate change affects weather events in Australia, traditional indemnity based policies are becoming more exposed to uncertainty. This uncertainty is being reflected in increased premiums and reduced cover for commercial entities across Australia. Parametric hail covers, such as the Hail Cover for Dealerships offered by Mainstay Underwriting, is offering the policyholder and the insurer less uncertainty, resulting in more affordable premiums. It's impossible to know the value of a disaster before it happens, so by setting a claim value for a defined event, such as hailstone sizes, the insurer has more certainty of costs and can offer lower premiums. [11]

Related Research Articles

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Insurance is a means of protection from financial loss in which, in exchange for a fee, a party agrees to compensate another party in the event of a certain loss, damage, or injury. It is a form of risk management, primarily used to protect against the risk of a contingent or uncertain loss.

<span class="mw-page-title-main">Life insurance</span> Type of contract

Life insurance is a contract between an insurance policy holder and an insurer or assurer, where the insurer promises to pay a designated beneficiary a sum of money upon the death of an insured person. Depending on the contract, other events such as terminal illness or critical illness can also trigger payment. The policyholder typically pays a premium, either regularly or as one lump sum. The benefits may include other expenses, such as funeral expenses.

<span class="mw-page-title-main">Vehicle insurance</span> Insurance for road vehicles

Vehicle insurance is insurance for cars, trucks, motorcycles, and other road vehicles. Its primary use is to provide financial protection against physical damage or bodily injury resulting from traffic collisions and against liability that could also arise from incidents in a vehicle. Vehicle insurance may additionally offer financial protection against theft of the vehicle, and against damage to the vehicle sustained from events other than traffic collisions, such as keying, weather or natural disasters, and damage sustained by colliding with stationary objects. The specific terms of vehicle insurance vary with legal regulations in each region.

<span class="mw-page-title-main">Reinsurance</span> Insurance purchased by an insurance company

Reinsurance is insurance that an insurance company purchases from another insurance company to insulate itself from the risk of a major claims event. With reinsurance, the company passes on ("cedes") some part of its own insurance liabilities to the other insurance company. The company that purchases the reinsurance policy is referred to as the "ceding company" or "cedent". The company issuing the reinsurance policy is referred to as the "reinsurer". In the classic case, reinsurance allows insurance companies to remain solvent after major claims events, such as major disasters like hurricanes or wildfires. In addition to its basic role in risk management, reinsurance is sometimes used to reduce the ceding company's capital requirements, or for tax mitigation or other purposes.

<span class="mw-page-title-main">Earthquake insurance</span> Form of property insurance

Earthquake insurance is a form of property insurance that pays the policyholder in the event of an earthquake that causes damage to the property. Most ordinary homeowners insurance policies do not cover earthquake damage.

Home insurance, also commonly called homeowner's insurance, is a type of property insurance that covers a private residence. It is an insurance policy that combines various personal insurance protections, which can include losses occurring to one's home, its contents, loss of use, or loss of other personal possessions of the homeowner, as well as liability insurance for accidents that may happen at the home or at the hands of the homeowner within the policy territory.

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Crop insurance is insurance purchased by agricultural producers and subsidized by a country's government to protect against either the loss of their crops due to natural disasters, such as hail, drought, and floods ("crop-yield insurance", or the loss of revenue due to declines in the prices of agricultural commodities.

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<span class="mw-page-title-main">Catastrophe bond</span> Risk-linked securities

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Critical illness insurance, otherwise known as critical illness cover or a dread disease policy, is an insurance product in which the insurer is contracted to typically make a lump sum cash payment if the policyholder is diagnosed with one of the specific illnesses on a predetermined list as part of an insurance policy.

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Stop-loss insurance is insurance that protects insurers against large claims. Stop-loss policies take effect after a certain threshold has been exceeded in claims.

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An insurance-linked security (ILS) is a financial instrument whose value is driven by insurance loss events. Those such instruments that are linked to property losses due to natural catastrophes represent a unique asset class, the return from which is uncorrelated with that of the general financial market.

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Caribbean Catastrophe Risk Insurance Facility Segregated Portfolio Company is an insurance company headquartered in the Cayman Islands. The sixteen original member-countries of CCRIF included participants in CARICOM, and the membership of the Board of Directors is selected by CARICOM and by the Caribbean Development Bank.

<span class="mw-page-title-main">Vehicle insurance in France</span> Compensation-based insurance for policyholder land vehicles in France

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The effects of climate change on extreme weather events is requiring the insurance industry in the United States to recalculate risk assessments for various insurance policies. From 2013 to 2023, U.S. insurance companies paid $655.7 billion in natural disaster claims with the $295.8 billion paid from 2020 to 2022 setting a record for a three-year period, and after only the Philippines, the United States loses the largest share of its gross domestic product annually of any country due to natural disasters while having the greatest annual economic losses in absolute terms.

References

  1. 1 2 Sengupta and Kousky (September 2020). "Parametric Insurance for Disasters" (PDF). Wharton Risk Center Primer.
  2. ↑ Unnava, Vaasavi (June 17, 2020). "Understanding Parametric Triggers in Catastrophe Insurance". Yale School of Management Program on Financial Stability Systemic Risk Blog.
  3. ↑ Kousky and Shabman (December 2015). "A Proposed Design for Community Flood Insurance" (PDF). Resources for the Future.
  4. ↑ Reguero, Borja G.; Secaira, Fernando; Toimil, Alexandra; Escudero, Mireille; Díaz-Simal, Pedro; Beck, Michael W.; Silva, Rodolfo; Storlazzi, Curt; Losada, Iñigo J. (2019). "The Risk Reduction Benefits of the Mesoamerican Reef in Mexico". Frontiers in Earth Science. 7: 125. Bibcode:2019FrEaS...7..125G. doi: 10.3389/feart.2019.00125 . hdl: 10902/16346 . ISSN   2296-6463. S2CID   167208358.
  5. ↑ Ruckelshaus, Mary; Reguero, Borja G.; Arkema, Katie; Compeán, Roberto Guerrero; Weekes, Khafi; Bailey, Allison; Silver, Jessica (2020-12-01). "Harnessing new data technologies for nature-based solutions in assessing and managing risk in coastal zones". International Journal of Disaster Risk Reduction. 51: 101795. doi: 10.1016/j.ijdrr.2020.101795 . ISSN   2212-4209.
  6. ↑ The Nature Conservancy. "A REEF INSURANCE PRIMER: Hurricane damages to reefs, repair and restoration options and costs" (PDF). The Nature Conservancy.
  7. ↑ "Parametric insurance policy to cover Mexico coral reef". Business Insurance. Retrieved 2020-11-13.
  8. ↑ Einhorn, Catrin; Flavelle, Christopher; Berehulak, Daniel (2020-12-05). "A Race Against Time to Rescue a Reef From Climate Change". The New York Times. ISSN   0362-4331 . Retrieved 2020-12-12.
  9. ↑ World Bank (March 2012). "Caribbean Catastrophe Risk Insurance Facility (CCRIF)" (PDF). World Bank.
  10. ↑ Traill, David (April 29, 2020). "Press Release: Tonga To Receive Record Insurance Payout Following Cyclone Harold" (PDF).
  11. ↑ Wood, Daniel. "Size matters: Mainstay Underwriting launches parametric hail insurance". www.insurancebusinessmag.com. Retrieved 2022-04-12.
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