Parametric insurance (also called index-based insurance) is a non-traditional insurance product that offers pre-specified payouts based upon a trigger event. Trigger events depend on the nature of the parametric policy and can include environmental triggers such as wind speed and rainfall measurements, business-related triggers such as foot traffic, and more. Examples of current parametric products include the Caribbean Catastrophe Risk Insurance Facility (CCRIF), the African Risk Capacity (ARC), and the protection of coral reefs in the state of Quintana Roo in Mexico.
Parametric insurance policies have most frequently been implemented in developing economies, oftentimes for agriculture insurance. In the US, there are proposals to implement parametric policies more often, specifically in the case of flood insurance through the National Flood Insurance Program.
Comparison to traditional indemnity insurance
Traditional indemnity insurance is structured so that after an event that leads to a loss, such as a fire, flood, storm, or car accident, the insurer reimburses the insuree for the total value of the loss, given no limits and deductibles are included in the insurance policy. To quantify loss, a representative from the insurance company accesses the damage. In a parametric insurance policy, insurance companies need to verify that the loss event exceeded the trigger event(s) specified in the policy. For weather-based parameters, this involves researching measurements from trusted third-party weather services or collecting sensor and satellite data to verify the magnitude of the weather event. Once the magnitude of the trigger is verified and "proof-of-loss" is obtained, the insurer disseminates the payout specified in the policy for the corresponding trigger event(s) to the insuree.
The main benefit of parametric insurance policies is that they offer faster payouts than traditional insurance based on the nature of the trigger event. Because it is quick to verify if the trigger event passed the threshold specified in the policy, parametric policies can payout quickly. These quick payouts are especially beneficial for the liquidity to successfully recover after a disaster strikes. In addition, parametric insurance is suited for hard-to-model, low-frequency but high-intensity losses as in catastrophic perils, weather-related risks in agriculture or other economic activities, and risks sought to be covered without sufficient history of losses captured as insurance-readable data. Finally, parametric insurance may reduce transaction costs involved in writing and administering insurance policies because there is less need for actual loss assessment for payment of claims or underwriting rating requirements to determine the premium based on liabilities and extent of risk sharing.
The main drawback of parametric insurance policies are that they often do not cover the full basis risk of the insured. Policies are based on parameters and therefore do not always cover the full damage that occurs.
Coral Reefs in Quintana Roo, Mexico
Part of the Mesoamerican Reef (MAR) is located off the coast of the state of Quintana Roo in Mexico, where Cancún is located. The reef has experienced degradation from pollution, storm damage, rising ocean temperatures, and increasing tourist activities. Recent analysis indicated that the reef prevents $42 million in damage to buildings and $20.8 million in damage to hotels annually. In response, Quintana Roo created the Coastal Management Trust Fund to purchase a parametric insurance policy for protecting and restoring the reef. The parametric policy has an annual maximum payout of $3.8 million and is triggered by wind speed. The payout changes based on the wind speed in the manner below:
- 100-129 knots --> 40% of maximum parametric payout
- 130-159 knots --> 80% of maximum parametric payout
- > 160 knots --> 100% of maximum parametric payout
Partners of the Quintana Roo government include the Nature Conservancy, the Cancún and Puerto Morelos Hotel Owners’ Association, CONANP, Mexican Universities and insurance industry representatives.
The insurance policy was triggered during Hurricane Delta in October 2020, for which the Coastal Management Trust Fund received $850,000.
CCRIF is an insurance company established in 2007 that allows Caribbean and Central American Countries to purchase parametric insurance products for weather catastrophes. By pooling their risks together, each participating country is able to purchase insurance for significantly less than if they had gone through the private market.
- Sengupta and Kousky (September 2020). "Parametric Insurance for Disasters" (PDF). Wharton Risk Center Primer.
- Unnava, Vaasavi (June 17, 2020). "Understanding Parametric Triggers in Catastrophe Insurance". Yale School of Management Program on Financial Stability Systemic Risk Blog.
- Kousky and Shabman (December 2015). "A Proposed Design for Community Flood Insurance" (PDF). Resources for the Future.
- Reguero, Borja G.; Secaira, Fernando; Toimil, Alexandra; Escudero, Mireille; Díaz-Simal, Pedro; Beck, Michael W.; Silva, Rodolfo; Storlazzi, Curt; Losada, Iñigo J. (2019). "The Risk Reduction Benefits of the Mesoamerican Reef in Mexico". Frontiers in Earth Science. 7: 125. Bibcode:2019FrEaS...7..125G. doi:10.3389/feart.2019.00125. ISSN 2296-6463. S2CID 167208358.
- Ruckelshaus, Mary; Reguero, Borja G.; Arkema, Katie; Compeán, Roberto Guerrero; Weekes, Khafi; Bailey, Allison; Silver, Jessica (2020-12-01). "Harnessing new data technologies for nature-based solutions in assessing and managing risk in coastal zones". International Journal of Disaster Risk Reduction. 51: 101795. doi:10.1016/j.ijdrr.2020.101795. ISSN 2212-4209.
- The Nature Conservancy. "A REEF INSURANCE PRIMER: Hurricane damages to reefs, repair and restoration options and costs" (PDF). The Nature Conservancy.
- "Parametric insurance policy to cover Mexico coral reef". Business Insurance. Retrieved 2020-11-13.
- Einhorn, Catrin; Flavelle, Christopher; Berehulak, Daniel (2020-12-05). "A Race Against Time to Rescue a Reef From Climate Change". The New York Times. ISSN 0362-4331. Retrieved 2020-12-12.
- World Bank (March 2012). "Caribbean Catastrophe Risk Insurance Facility (CCRIF)" (PDF). World Bank.