What Is Parametric Insurance?

02nd Dec 2020

By Ori Cohen

Parametric insurance isn’t new. It’s been around since the 1990s, but until recently, it was mainly used to insure nature-related risks such as hurricanes, floods and earthquakes, or within capital markets. 

Today, the parametric insurance model offers untapped potential and, when applied in innovative ways, it can benefit every player in the ecosystem. Parametric models have emerged as a valuable way to help the insurance world fulfill the needs of the under-insured while addressing customers’ increasing demand for “instant everything.”

With protection gaps growing as new risks continue to emerge and new technologies and data sets becoming available, the traditional insurance industry is not always adapting fast enough to meet the demands and opportunities of the changing environment. Parametric insurance contracts work differently than conventional insurance policies. 

When thinking about traditional insurance practices, what comes to mind is the arduous process and long wait times for reimbursement. The story goes like this:  A complicated and detailed forensic investigation begins with a team of IT experts, lawyers, and insurance experts evaluating the damage and determining the value of the loss. Because the work is tedious and subject to human analysis and assessment, months go by before the damage becomes attached to a dollar amount. The insured and insurance company can spend additional months negotiating the reimbursement amount, which can add up to more than a year before payment is received. 

Parametric insurance stands in stark contrast to traditional insurance’s approach and provides protection against previously uninsurable risks such as IT downtime.

What is Parametric Insurance?

Stemming from the word parameter, parametric insurance policies are triggered when a set of objective criteria are met. Instead of measuring and verifying damages, parametric insurance pays a fixed amount based on a predetermined formula linked to objective occurrences. 

Parametric insurance, also known as event-based insurance or index-based insurance, is mostly used to cover natural disasters because the events are objective to both the insured and insurer, eliminating the moral hazard that often prevents the coverage of certain types of loss. When the insured event occurs, payment is triggered. This process eliminates fraudulent claims and the need to go through a claims settlement process. In turn, that reduces claim adjustment costs and creates a smooth, transparent and stress-free experience. 

How Parametric Policies Work

Although not always easy to implement, parametric insurance policies follow a simple structure:

  1. The policy determines a coverage trigger, often connected to an index that is linked to underlying financial loss. A payout amount in the case of the policy being triggered is also determined.
  2. The reference index is monitored.
  3. Once the specific triggers are met, the policy pays out without the need for a claims settlement process.

Parametric Insurance Benefits at a Glance

✔Provides coverage for previously uninsurable circumstances, closing protection gaps

✔Transparent determination of insurance payout when the threshold is met, providing certainty

Cuts claim settlement and underwriting costs 

✔Flexible to meet customer needs

No restrictions on how the payout is used

Predetermined payout formula allows for managed exposure

How We Apply the Parametric Insurance Model to Cover Downtime Events

To better understand how we use the parametric model to cover IT downtime and business interruption insurance, it’s best to compare it to traditional insurance as it would be applied to downtime insurance.

Coverage

Traditionally insurance has covered business interruption for physical damages, commonly caused by fire, floods, natural disasters, vandalism or equipment failure. Over the last decades, non-physical damage business interruption has become a greater risk for businesses. This is more difficult for traditional insurers to handle, particularly when defining triggers, evaluating losses due to reputational damage, or protecting themselves from the risks associated with moral hazard. 

Today’s businesses rely heavily on third-party IT service providers for cloud computing and storage, electronic payment services, customer relationship management solutions, and more. When one of these external services goes down, the business grinds to a halt. This has created a situation where the risk is external to the business (and not internal like before), meaning the company cannot influence the downtime event. Parametrix Insurance’s policies can cover this type of business interruption because, instead of insuring against damages, the policies are built on the likelihood an event will occur; the probability of occurrence is based on current and historical data, removing the uncertainty.  

Contract Terms & Restrictions

Relatively new risks such as downtime are challenging for traditional insurers to monitor, and because of that, the contracts offered are restrictive. Included in the contracts are deductibles, exclusions, 8-12 hour waiting periods, and other conditions that must be met before the insurance company will even discuss a payment. Traditional contracts limit coverage to areas where insurers believe that moral hazard is small, leaving some of the most important causes of loss not covered. This can include not covering SLA liabilities and “discretionary” compensation to customers, both of which are essential to keeping a business up and running.

Parametrix Insurance contracts provide transparency regarding payout and protect businesses against causes of loss that cannot be covered under traditional insurance. The policies are flexible in terms of waiting periods and policy limits. For example, companies have different service level commitments, high or low-reliant products, and various revenue cycles. One company may want the policy to trigger payment after 3 hours, while another company would like it triggered after just one hour.

A further differentiation comes in how payments can be applied to business needs. Parametrix Insurance policies don’t come with restrictions, giving companies the freedom to use the payment for any business activity they see fit. 

Claims Process & Payout Timelines

With traditional insurance, the claims process is slow and costly, involving many professionals’ expert opinions, including adjustors, investigators, lawyers, and more.  Coverage is limited to a narrow range of perils and loss types, spanning only a small spectrum of a downtime event’s real financial loss. The losses covered will be settled based on subjective criteria and sometimes need to be negotiated between the insurer and insured, lengthening the process. It’s common for businesses to wait months or years to be reimbursed for damages, dramatically handicapping the company.

Since Parametrix Insurance policies are event-based, and the event’s occurrence and duration are known, the payout is simply determined by the formula laid out in the policy, making the claims process straightforward and hassle-free. Payment is transferred to the insured company within days, allowing businesses to recover quickly.

Parametric Insurance on the Rise

In the US alone, 9 out of 10 large businesses experience one network outage per year, while 69% suffered from two or more, resulting in losses topping $700 billion per year. The reliance on third-party IT service providers, and the subsequent financial damages that occur when an outage happens, highlight the need for business interruption insurance to be expanded.

Objective monitoring and new data collection practices enable the parametric model to be applied to more insurance coverages. By doing this, insurance providers like Parametrix Insurance can determine policy triggers and provide experience-based policy pricing. With these critical mechanisms in place, business interruption coverage can be extended to provide an additional layer of protection for modern, tech-reliant businesses.