Is Parametric Insurance the Future of Catastrophe Coverage?

According to numbers compiled by Allied Market Research, the parametric insurance market is projected to explode over the next 8 years, climbing from about $11.7 billion in 2021 to almost $30 billion in 2031.

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Part of this increase can certainly be explained away as a result of the increasing rate of occurrence for what had previously been more rare extreme weather events, for one. As businesses and individuals both become more concerned with the incidence of these occurrences and their own susceptibility to extreme weather and other natural catastrophes, additional coverage is a common, rational response, which in turn is projected to boost the parametric insurance market proportionately. 

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At least some of the credit for the increase in popularity of parametric coverage up to this point, however, has to go to the efficiency, transparency, and certainty that have been hallmarks of parametric insurance since it was first introduced.

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Born out of necessity when many players in the property and casualty insurance market were struggling to remain solvent in the 1990s in the midst of managing major hurricane damage claims, the origins of parametric insurance began as a means of offloading some of that risk on to capital markets via the issuance of bonds that only paid out a certain amount of money if a certain type of event occurred that met a certain threshold of severity. 

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The binary nature of that triggering event (i.e. either a qualifying event occurs or it doesn’t) and its predetermined payout are the lasting legacies of those early bonds and are the key defining features that have led parametric coverage to grow far beyond the property and casualty market to now include cybersecurity, financial lines, and management liability coverage, as well -  and it doesn’t appear to be not stopping there.

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In a parametric policy, it will be very clearly stated exactly what type of event is covered and the level of severity (as well as how that severity is measured and determined) that will trigger a payout. It will also be equally clearly laid out exactly how much will be paid out in the event that an event that meets the requisite criteria occurs. 

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The only thing needed to file/process a parametric claim is proof that a qualifying event happened, at which point the check should be in the mail and heading directly to the policy holder.

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Contrast this relative simplicity with that of a traditional catastrophe insurance claim, for example, which can leave policy holders bogged down in the weeds for years potentially as a variety of assessments must be made and potentially disputed, such as the amount and value of damage caused, as well as even more nebulous causation issues if there is any gray area in terms of how much damage was caused by covered vs. uncovered factors. 

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The speed of the payout for parametric claims combined with the certainty of the predetermined amount are certainly two of the main factors driving this market growth, but the sheer transparency of the process and the additional peace of mind that it provides to policyholders should not be underestimated. Given the web of provisions and boilerplate language that typically make up traditional insurance policies as well as the seeming impossibility for policyholders to know without a doubt whether or not some events are covered under standard policies, the ‘cut-to-the-chase’ nature of parametric agreements can be refreshingly direct and concise.

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Improving technology is another factor that has significantly contributed to the rise of parametric insurance, as well. Whereas once upon a time, parametric coverage was relegated for the most part to risk exposures that would-be policy holders were having trouble covering on the traditional market, the reason that traditional coverage was hard to come by and the reason that parametric coverage was an unideal last resort to address those exposures were one and the same - lack of good data.

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In the era of big data with sophisticated techniques for both collecting and analyzing information, not only can damage probabilities and estimates be computed with a greater degree of confidence, leading to more precisely valued predetermined payouts in parametric policies, but technology also enables much more sensitive and specific payout triggers, with atmospheric sensors capable of detecting the exact size of hailstones in a given area or seismic equipment that can detect vibrations in the earth with a level of precision that was previously impossible to obtain. 

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Despite the meteoric rise of parametric coverage, traditional insurance still serves a number of purposes quite well and isn’t going anywhere in the short term. For certain risks and exposures, including simply adding an extra layer of protection that can increase liquidity and flexibility while you’re navigating the traditional claims process, the value of parametric insurance is repeatedly proving its worth across an already considerable market that is poised to triple in size in the coming years, and looks to be an opportunity that companies and the insurance brokers that serve them would benefit from exploring further.

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You can read more about parametric coverage here. Looking for more exclusive content? Check out what’s new on the Mployer Advisor blog, and be sure to check out Mployer Advisor’s new podcast “This Week in Benefits.”

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