Why parametric insurance is radically reshaping the insurance industry

Parametric insurance is constantly growing. Referred to as a new spin on an old product, I believe that it’s much more. It’s an opportunity for a paradigm shift in the world of insurance products.

That’s because parametric (index-based) insurance enables protecting against a wide range of risks, exposures and threats. It’s not merely an indemnification product; it’s coverage where a benefit payable is determined prior to policy purchase, by estimating the loss at superior accuracy and speed.

This is possible through the integration of machine learning algorithms and advanced actuarial predictive models, which allow the development of powerful tools ideally suited to swiftly predict and hedge risks in a digital era of challenging data, thus providing optimal insurance solutions in fast-changing environments.

Parametric insurance arose from the desire for a faster claim management process. The main differences with traditional indemnity insurance policies can be summarised as follows:

• Compensation payment trigger: Payment is automatically triggered by an event exceeding a predefined parametric threshold, rather than after a long process to determine actual loss or damage.
• Payment structure: Payment can be structured according to varying, predefined conditions, i.e., we’ll pay x if this occurs, and y if that occurs, replacing reimbursement based on the actual loss suffered.
• Customer appeal: Complex policy conditions, deductibles and exclusions that often are a deterrent to consumers, are replaced by a simple and intuitive scheme, correlating the chosen index with the payout and loss sustained, significantly enhancing customer satisfaction.

To date, implementation of parametric insurance is mostly related to agricultural insurance products against environmental factors, where it has an expanding role for coverage against disasters. But why not utilize the capabilities of parametric insurance for other cases?

The concept of parametric insurance can ideally be implemented in insurance products that cover simple events, where consumers have no ability to affect the outcome, such as flight delays, missed connections, lost luggage and the cancellation of gigs. In all these cases, it’s simple to understand the trigger for loss; the compensation for loss can be clearly predefined with an undebatable amount; and the payment can be transferred automatically without having to file any claim.

Such implementations meet consumer – and particularly millennial – demands for simple and transparent products, which eliminate the need for completing time-consuming forms and handling long claim processes. Parametric-based offerings can deliver automatic compensation and the worry-free, hassle-free experience consumers expect. They’re clearly going to revolutionize the world of insurance.

About the Author
Udi Makov is a professor of statistics at the University of Haifa, where he serves as the chairman of the Actuarial Research Center and director of the Actuarial Science MA Program. His current research focuses on predictive modelling and risk measures. As Lead Actuary in Setoo, Udi is responsible for promoting actuarial research in the context of insurance prediction and pricing, and for introducing aspects of advanced statistics into algorithmic development.