Parametric insurance: breaking the mold of traditional insurance

"Many risks are under-insured, leaving ample room for digital competitors and new business models."

By | 4 minute read | January 22, 2018

Photo: Jonathan Ford | Unsplash

Because extreme weather events are now seemingly more common than ever before, insurance claims are seeing record increases, and the demand for disaster insurance is reaching unprecedented levels. Insurance companies are being challenged to offer new ways to respond to these disasters, both to expedite relief for their clients and to develop cost-friendly and profitable products, all while reducing operating costs.

Parametric insurance, also known as index insurance, is an innovative product that functions differently than the traditional model of insurance coverage. It’s initiated by and paid to the policyholder based upon a set of specific parameters, along with a predetermined sum that foregoes the traditional claims process.

Expedited real-world applications

Parametric insurance, in its current form, is often related to weather and other natural occurrences. Parametric insurance can be used in place of traditional insurance policies in scenarios such as earthquakes, storms and floods. Parametric insurance is measured by an agreed upon independent third-party metric, that with an evidenced presumed loss is the trigger which determines the payout. Hurricane wind-speed and strength metrics are one example that could be utilized to trigger a parametric insurance policy.

The owner of a farm could purchase a parametric insurance policy for air pollution, outlining a specific threshold of the air quality index scale, a commonly used and accepted metric of air pollution, that would stunt crop output. When the air quality index reaches a certain level, a farmer’s crop yield would decrease, triggering the parametric insurance policy. Measurable, objective metrics such as soil moisture, biotic or abiotic data and other distinct environmental variables will prepare an insurance company to underwrite and offer financial protection against these disasters.

The relationship between environmental factors and a parametric insurance contract positions the IBM Weather Company insurance solutions to deliver predictions, real-time alerts, and help insurers and businesses plan for a seasonal event. After an incident, The Weather Company acts as a third-party ledger and system of record confirming the event with precise data analytics. Future predictions for parametric contracts are made easy by using historical data API’s with History on Demand Data.

Parametric insurance is not only applied in industrial and commercial scenarios, but also applied on a more personal and individual scale. An innovative example is “travel insurance provided by fizzy”. Fizzy offers tailored coverage for an airline traveler who has the option of purchasing a parametric insurance policy that returns a portion of their airfare in the event of a flight delay. Travelers can subscribe to a personalized parametric insurance policy up to 15 days before departure without the hassle of endless paperwork like in traditional insurance claims.

Streamlined insurance claims process

Unlike a traditional insurance policy that involves filing a post-event claim with the subsequent investigation and adjustment, a parametric claim improves the claims process efficiency. Once the parameters of the policy have been met, the policy is automatically activated, and a payment is dispersed in a simplified manner for payment of damages suffered during any type of natural disaster. With no documented proof necessary of losses beyond the predetermined parameters, the claims process is settled immediately. This expedited claim process features a vast reduction of paperwork, fewer claims investigation hours, and an overall lower operational cost to the insurer.

A progressing blockchain application

Parametric insurance coverage is typically used for difficult-to-insure risks. For a coverage-type event, all clauses in the parametric contract can be encoded using smart contract language, allowing Blockchain to keep track of all claims. Insurer payouts and account adjustments are automatically performed based on event trigger confirmation by the trusted source. For a contract event, parametric contracts are not related to actual loss, but to actual event occurrences or certain index thresholds.

The smart contract, combined with event triggers from off chain data sources (trusted & secure information) can be used to partially or fully to automate the operation of these policies (e.g. CAT swaps setup). Off-chain data sources (such as IoT device events) capture data on usage related to shared automobiles, homes, commercial spaces, etc. and offer on-demand utilization related policies. This gives rise to a whole new class of on-demand insurance products. Creating a no-touch, frictionless procedure can eliminate human error in the claims process and could potentially save insurers millions every year and produce a better customer experience.

Blockchain and parametric insurance have limitless possibilities. Take the recent IBM and Maersk demo cross-border supply chain solution on Blockchain Hyperledger as a starting point. In the future, if parametric weather data was integrated into the perishable product and the transportation life cycle, the entire supply chain readiness would take this to the next level of business readiness.

Disruption in the insurance industry

Recently, we’ve been hearing about disruption in the insurance industry. The fundamental potential for disruption in the insurance industry is displayed in the vulnerability of both mature and emerging markets. Many risks are under-insured, leaving ample room for digital competitors and new business models.

In some cases, old processes, limited customer connections, and complex products hinder some insurers and pave the way for precise differentiation by new entrants. Parametric insurance is another example of how this is happening. In 2018, expect to see an increase in parametric solutions as business evolves, untested value propositions, and new sources of revenue.