Parametric Insurance: An Introduction

Updated: Jan 19

‘Parametric Insurance ’ — sounds like boring insurance jargon doesn’t it?! It’s the kind of drinks party ‘conversation killer’ that will have your guests running for the door. We have all seen it.

However, this is not the case. Parametric insurance is much simpler and has the potential to be far more powerful, varied, exciting, and innovative than traditional insurance. This article will explain why.

  • Parametrics: The Basics

  • What Makes Parametric Insurance So Great?

  • BirdsEyeView’s Crop Insurance

  • Exciting New Beginnings

Parametrics: The Basics

Everyone knows how traditional insurance works. Think about the insurance you buy for your car or house. You buy a policy from your insurer who agrees to pay you should you incur a loss. This is known as the principle of indemnification. Damage must have actually occurred to your insured asset, and maybe the insurer will send a loss adjustor round to check the damage. In most cases, this traditional model of insurance works perfectly well.

However, there are thousands of individuals and businesses that can’t access insurance to protect them from potentially devastating events such as earthquakes, pandemics, hurricanes, droughts, and flooding. Traditional ‘indemnity insurance’ simply can’t provide protection for these kind of events. Swiss Re estimate that there is a global protection gap of around $180bn for weather-related risks. For example, the agricultural sector is highly susceptible to both drought and flooding. However, it’s too difficult for the insurer to accurately measure crops both pre and post-loss. How does a loss-adjustor accurately measure the damage caused to 1000ha of barley? Existing technologies make collecting the required data nearly impossible. Therefore, cover is rarely available.

This is where parametric insurance, such as the weather-risk crop insurance provided by BirdsEyeView, can step in. Parametric insurance pays out when a ‘pre-determinedevent occurs. These pre-determined events are also known as ‘triggers’ or ‘parameters’ (hence parametric) and can take a variety of forms. For example, when a pre-determined level of rainfall occurs or a earthquake of a chosen magnitude occurs. To explain, let’s look at an example:

Parametric Earthquake Insurance: Californian Coffee Shop Chain

A well-known Californian Coffee Shop chain (lets call them ‘Jim’s Java Hut’) is worried about the financial damage and business interruption a major earthquake could cause. There will be damage to their shops, a loss of revenue whilst the shops are rebuilt, reputational damage, and potential mental health complications for employees. The list goes on. Their insurers won’t cover them for earthquake damage because it’s too difficult to calculate all the financial losses that could occur. Jim’s Java Hut estimate that potential business interruption damages would cost around $200m. They go to their insurer and ask to buy a ‘Parametric Earthquake’ Insurance policy.

  1. Jim’s Java Hut approach their insurer and say they would like to buy $200m worth of cover.

  2. They agree with their insurer that, if a Magnitude 5.0 earthquake occurs, their policy will trigger (this is the pre-determined event!). It’s agreed that the US Geological Society will be the 3rd party making these measurements.

  3. Jim’s Java Hut pays their insurance premium as normal. As soon as a Magnitude 5.0 or greater earthquake is reported by the USGS, the insurer pays out the full $200m immediately. Simple.

There is no need for loss-adjustors to be sent out to assess the damage. They are indemnified should this pre-determined event occur.

1994 Northridge Earthquake. Los Angeles Times

What Makes Parametric Insurance So Great?

  1. Protection Gap: Parametrics can provide protection for risks that were previously regarded as being ‘uninsurable’. For example, crops are regarded as being too difficult to measure by insurers. The data and technology just isn’t available to accurately monitor crops and assess any damage quickly and at a low cost. Therefore, it’s rarely available. Parametric’s can complement traditional insurance to cover these gaps.

  2. Speed: There is no need for a loss-adjustor to be sent out to assess the damage. This can take months in the aftermath of a natural disaster. The customer is immediately indemnified once the trigger has been reached. Customers can quickly get back to business as usual.

  3. Cost: With traditional insurance, the insurer needs to pay loss adjustors, claims teams, legal support etc. All these costs ultimately get transferred to the customer’s premium. Insurers are also uncertain about the true financial damage that will result. This uncertainty, again, translates into inflated premiums.

  4. Customer Flexibility: The customer can choose both the amount of cover they want to buy, and the trigger level. For example, a cereals grower with well-draining fields in East Anglia might not be too worried about heavy-rainfall in October. However, they may be worried about drought in the summer months. Therefore they would choose a drought policy that kicks-in when rainfall falls below a chosen level. Each customer can tailor their policy depending on their individual preferences, pain points, and risk appetite.

  5. Transparency: With traditional insurance, the customer doesn’t receive a payout until the damage has been assessed by a loss-adjustor. Not only is this time-consuming, but it can result in valuation-disagreements and haggling with the insurer. Parametric insurance pays out a pre-determined amount, should the trigger have been met or exceeded. No questions asked.

BirdsEyeView’s Crop Insurance

Now that we understand parametric insurance, we can take a look at BirdsEyeView’s crop insurance.

  • 80% of crop failure is driven by either excess-rainfall or drought.

  • Climate change-induced natural disasters are increasing in both frequency & severity. The MetOffice predicts that the prevalence of these severe weather events will double by 2050.

  • Farmers are unable to purchase appropriate financial protection.

  • Easy access to uncomplicated crop insurance provides farmers with financial security. In the developing world this can help alleviate those in the agricultural sector from the poverty trap. This economic resilience is required to ensure we can meet the increasing demands on global food supplies.