Chapter 2: Data driven claims; welcome to the future
The phrase parametric insurance has been gaining a lot of traction in the industry. While the term itself is relatively straightforward, many insurers struggle to explain exactly what it means. Although parametric solutions have existed for quite some time, the digital infrastructure has only recently evolved to the point necessary to deliver them effectively. Remember that data we talked about in the previous chapter? Using data, compiled from independent sources, to set objective limits or boundaries is a key piece of the parametric puzzle.
If you take nothing else away from this chapter, let it be this:
Parametric insurance is not intended to replace traditional insurance, but as a complementary solution to cover a myriad of alternative risks.
It's being used most frequently within property insurance to cover natural disasters (e.g. earthquakes or floods) but will become more widespread over the coming years. It has proven an effective method of securing additional coverage for more difficult to insure risks.
What exactly is parametric insurance?
Let’s start by taking a step back. What is a parameter? You no doubt already know what a parameter is, but for the sake of clarity, it’s a numerical (or other measurable value) that defines a limit or boundary. If we combine this definition with a very simplified definition of insurance, we can conclude that parametric insurance is: an insurance product with a predefined limit for a measurable value that if breached results in a settlement payment.
Of course, we wouldn’t be talking about insurance if things didn’t get slightly more complex than that. For example, the payout size will often be specified in advance along with a range of various thresholds that correspond to different amounts. Within the insurance industry, these thresholds are referred to as “triggering events'' and result in a payment being automatically sent when the trigger event occurs. The value of the payout is not necessarily dependent on the actual cost to repair or replace as with traditional insurance, but a parametric policy provides a guarantee that can alleviate concerns about certain types of risks.
To illustrate more clearly, say you live in a part of the world prone to hurricanes, which aren’t typically covered by a standard home insurance policy. You may opt to obtain a parametric policy that will cover you for this risk. The policy you decide to buy indicates 2 parameters used in conjunction to determine what sort of payout you would receive: the hurricane category and the distance from the eye of the storm to your address. In the US, this data can be obtained through the US National Hurricane Center which categorizes hurricanes based on wind speed, 1 being the least dangerous and 5 being the most.
In each of these scenarios, the “triggering event” is the occurrence of a hurricane with varying intensities. When combined with how far away your home is, you can see the percentage of the payout you would receive from your parametric policy. As the category of the hurricane increases the higher the percentage of the payout you would receive; however, if your home is further away from the storm, the percentage would decrease accordingly. Make sense? Great!
How is it different from regular insurance?
As we mentioned in the last chapter, many event cancellation insurers don’t have the necessary events expertise to accurately evaluate your risk. This often results in policies that misrepresent where your losses could occur. That’s where parametric insurance comes in. It puts you, the expert on your events, in control. You’re up close and personal with your risks so not only do you understand what could go wrong, but you can put a more realistic value on what you stand to lose if a disaster occurs. In this sense, parametric policies are highly customizable, allowing you to obtain the cover you need as well as include things that may not be insured by your standard policy.
Generally speaking, traditional insurance has a complex claims process where each claim is assessed by a claims adjuster on an individual basis. While open to a fair amount of subjectivity, the time spent evaluating usually results in a payout that accurately aligns with the cost to repair or replace. With parametrics, it’s more of a “what you see is what you get” type of situation. If a specific thing happens, you receive a payout - done. No investigation required and claims can be automated, eliminating the need for a human element altogether. Due to the quantifiable policy terms and clear wording, the trust gap between carriers and customers becomes non-existent. However, due to the pre-agreed payment structure and elimination of the adjustment process, a parametric payout could end up being more or, more worryingly, less than your actual losses.
It’s important to reiterate, parametric insurance is not intended to replace traditional insurance but aims to provide cover for emerging risks or risks that until now have been considered uninsurable (i.e. natural disasters), which brings us to...
Closing the gap (yup, here we go again)
Hopefully by now you have a firm grasp of the protection gap, the difference between the amount presently insured and the amount that could/should be insured but isn’t (check out the Introduction and Chapter 1). The daily development of new and unforeseen risks, such as say...a pandemic, make it extremely challenging for both insurers and the insured to gauge the type of cover and how much is needed for every eventuality. In 2019 alone, Swiss Re estimated $140 billion dollars in losses from “natural and man-made disasters” of which only $56 billion was covered by a traditional insurance policy. The increasing threat of climate change, growing poverty and expanding wealth inequality will only serve to exacerbate this situation.
Without alternative solutions, that uninsured piece of the pie will continue to expand rather than shrink. Leaving more people and businesses exposed to losses they can’t withstand. With parametric insurance, however, it becomes possible for these firms and individuals to obtain a smart solution for previously uninsurable risks. Thus helping minimize individual risk exposures, as well as providing greater stability to economies as a whole.
The good, the bad and the ugly
As the evolution of parametric insurance continues, the accuracy of triggers and corresponding payouts will no doubt progress, offerings will become more widespread and any number of other benefits may emerge. Even though the offerings are currently limited, it’s not difficult to see how these policies will benefit businesses and individuals alike in the near future.
Parametric solutions offer significantly more transparency than your standard contract. If X occurs, then you will receive a sum of money. For policyholders, it removes most of the guesswork. You know exactly when a payout could be expected.
Remember that other gap we mentioned, the information and trust gap. The disconnect between what customers think their policy offers and what it actually does cover, this lack of transparency is no longer an issue with parametrics. You’re in the driver’s seat and can feel assured of the payout you will receive when something goes wrong.
Due to the cut and dry nature of the claims process, the ability to automate means payouts could occur almost immediately with no human intervention. Putting money swiftly in the hands of firms and individuals when they need it most to recover.
Parametric insurance is still a pretty new concept in the insurance industry which means it isn’t without its shortcomings. A good parametric policy requires very specific and well defined triggers, which requires an intimate understanding of the financial impact of possible risks. Despite incredible improvements in data capture, there’s still a long way to go when it comes to accurately assessing these risks. Since payouts are reliant on the accuracy of impartial data sources, the predetermined values could be inconsistent with actual circumstances. Unfortunately, nothing is foolproof.
What could parametric insurance mean for events?
Having a defined set of parameters that will guarantee you a payout if something threatens the safety of your fans or staff removes a significant amount of pressure. With the knowledge that you’re covered for a given situation, you can make confident, data-driven decisions about cancelling, postponing or curtailing an event instead of putting your team and attendees at risk by forging ahead. Additionally, if the trigger’s related to a forecasted schedule, you could cancel your event early, not only ensuring the safety of your construction team, but giving you even more financial security by suspending expenditure and saving resources that would otherwise be lost.
Let’s consider another festival example. This time, let’s assume the event is only days away and everything is still going according to plan. You take a minute to look ahead to the day of the event and the forecast looks, hmm, less than ideal. Luckily, your event cancellation policy has a trigger for heavy rainfall using an impartial weather provider. On the morning of the event, the forecasted rainfall is set to breach this trigger and clearly make the event too dangerous to put on. You cancel in confidence knowing that the terms of your policy have been met and your expenses will be compensated swiftly, without putting anyone in any needless danger.
We don’t have to tell you that events operate on razor thin margins (especially during peak season). The level of automation that’s possible with parametrics not only means a quick and easy claims process, but could result in a payout almost immediately. With a payout already in your pocket, you can confidently focus on what’s next rather than dealing with what’s already in the past.
Out with the old, in with the new
When it comes to financial protection, there’s no one size fits all solution. Parametrics could offer customers the option to buy specific policies that meet their individual risk appetites and provide protection against the precise risks threatening their business. Parametric insurance for the events industry is still some way off, but we can see it becoming the next big thing in insurance for live entertainment. In fact, a type of parametric insurance that has recently surfaced in the market is revenue protection. For events, this could mean cover for lower than expected ticket sales or concession purchases as a result of something outside of an event organizers control, e.g. storms.
We’ve covered insurtechs, what they are and how they’re bringing the insurance experience into this century. New entrants are using technology to improve the end to end process for the consumer by providing innovative solutions that are more transparent, flexible and competitive. We’ve talked about how data can help you get the type of cover you actually need at a price that makes sense and reduce your risks in the process. On top of all this, what if we told you there was a less complicated way to buy insurance? That you could purchase a policy online from a source you already trust. Up next we’ll be talking about embedded insurance - insurance when you need it, where you need it.