In its simplest form, parametric insurance refers to a predefined event severity threshold triggering a predefined payout. Rather than underwriting insurance for the loss that has occurred from an event, firms offering parametric coverage insure against an event occurring.
Unlike traditional insurance that will make payment after a full loss investigation has occurred, payment is made when an event has reached a certain magnitude. Therefore, offering instant financial relief so that recipients can react to the event as it happens.
There are typically three stages to the payout process:
A catastrophic event occurs – such as a flood, hurricane, earthquake or wildfire.
The event reaches the triggering parametric criteria – the provider will have pre-defined triggers, designed to detect the severity of the event and determine the consequential payout.
An alert triggers an automatic pay-out mechanism – depending on the severity of the event, an agreed amount of aid will be paid by the provider.
This form of insurance is still relatively new to the market and is expected to be a key tool in closing the insurance gap. As the operator does not need to provide coverage for a physical asset or piece of infrastructure, parametric insurance can be offered across areas of the world where data is scarce.