The Pros and Cons of Parametric Insurance

Businesses need new ways to manage their risks. Many are turning to parametric insurance. However, as with all insurance options, there are both pros and cons to consider.

What Is Parametric Insurance?

Before diving into the pros and cons, let’s review exactly what parametric insurance is.

Parametric insurance pays claims based on the occurrence of a triggering event. The claims amount is based on the magnitude of the event. For example, a parametric insurance policy that provides coverage for hurricanes will pay out based on the location of the hurricane and the category of the storm. This is unlike traditional insurance, which pays out based on actual losses.

The concept is appealing to many businesses that are struggling to secure adequate insurance in the traditional market. According to Allied Market Research, the COVID-19 pandemic sparked increased interest in parametric coverage. The global parametric insurance market was valued at $11.7 billion in 2021 and is expected to reach $29.3 billion by 2031.

Wondering if parametric insurance may be useful for your organization? Below you’ll find important pros and cons to consider.

Pro: Parametric insurance facilitates a fast payout.

The normal claims process can take time because an insurance adjuster needs to assess the loss to determine both its value and whether the insurance policy covers the loss. This can take days, weeks, or even months, especially following a widespread disaster that overwhelms insurance professionals with a high volume of claims while making travel to the impacted region difficult.

Parametric insurance bypasses all these issues. Claims payouts are based solely on the triggering event, meaning there is no need to assess actual losses before issuing a payment. As a result, claimants receive their money faster, which gives them funds to use on immediate needs and accelerates their recovery from the loss.

Con: The parametric payout may not be enough to cover all losses.

Although separating the claims payout from the actual losses speeds up the claims process, it also means the claims payments may not reflect the actual losses. In some cases, this could work to the policyholder’s advantage by resulting in a payout that exceeds the actual losses. However, it’s also possible the payout could fall short, leaving the claimant with uncovered costs.

For example, consider a manufacturer that buys a parametric insurance policy to insure against flooding. After a flooding event, the policyholder receives a claim payment of $100,000, based on the criteria set forth in the policy. If the policyholder has losses of only $80,000, the claim is more than enough to cover the losses. On the other hand, if the policyholder has losses of $150,000, the payment leaves the policyholder with $50,000 in uncovered losses.

Pro: Parametric insurance can provide coverage for many hard-to-insure risks.

Policyholders often use parametric insurance to cover natural disaster risks, such as wildfires and hurricanes. However, this form of coverage is also suitable for other types of loss events. For example, Deloitte says parametric policies can cover cyber exposures and even operation downtime caused by cloud outages. This option can help businesses secure coverage for risks the traditional market won’t touch.

Con: Parametric insurance does not offer broad coverage.

Whereas some traditional insurance policies are specific to one risk (such as flooding), many cover multiple loss events. A commercial property insurance policy, for example, typically covers fire, hail, wind damage, and other losses. However, parametric policies usually cover one specific peril, such as wildfire. As a result, policyholders may need additional policy types (including more conventional policies) to cover all of their exposures.

Pro: Claim disputes are less likely.

Claim disputes can stem from a number of issues. For example, the policyholder and insurer might disagree on the value of a loss. Disputes can also arise over the interpretation of a policy and whether coverage should exclude a particular loss. These disputes can become bitter and sometimes lead to litigation, costing both parties time and money.

Disputes like these are not typically an issue with parametric insurance because the payout is based on the triggering event and not actual losses. The policy should include criteria for how the insurer determines a loss event, so there is little to dispute.

Are You Interested in Parametric Insurance?

No product is perfect. Despite the potential drawbacks, though, parametric insurance offers many benefits that make it attractive in today’s risk management landscape. To explore your parametric insurance options, contact us.

Learn more about the types of risks parametric insurance can cover.