Parametric insurance is an insurance that does not cover for pure loss, instead, a predetermined payment is received upon the occurrence of a catastrophic natural event which results in a loss. An individual will have to purchase the parametric insurance with a predefined amount that will be paid out as agreed on predefined terms. Unlike other insurance policies, this insurance does not attempt to indemnify for an actual loss that has been sustained. Parametric insurance has been available for a long time, however, it is only recently when they have become a part of corporate insurance.
Who benefits from parametric insurance?
This type of insurance benefits companies that are exposed to high-intensity losses due to the occurrence of a catastrophic natural event rather than a small business that can be protected through traditional insurance programs. Parametric insurance provides businesses to transfer risk through parametric coverages which normal insurance policies are limited too.
Differences between parametric insurance and traditional insurance
Parametric insurance has a different function as compared to traditional insurance which is generally obtained by many people. Following are the key differences in the policies of the two insurances:
- Coverage: Parametric insurance provides coverage payout according to a predetermined parameter as compared to traditional insurance which provides coverage for the actual loss incurred.
- Term: A parametric insurance may be offered on an annual basis or a longer period while traditional insurances are generally offered on an annual basis or shorter period.
- Payment and claims: The payout period of traditional insurance is more complex and time-consuming as compared to parametric insurance that is paid out in a few days. This is because traditional insurance coverage is based on the pure loss sustained after an event while parametric insurance coverage is based on a predefined payment based on a predetermined parameter.
- Structure: Parametric insurance is a customizable product while traditional insurance has limitations and not uniquely tailored to meet individual client needs.
- Basis risk: Parametric insurance determines risk using pre-set parameters and is exposed to a greater basis risk as compared to traditional insurance which includes conditions, the interest of insurer, the deductions and exclusions.
Benefits of parametric insurance
Due to the difference in the structure of the insurance products and the nature of the risk it provides for, parametric insurances have benefits over traditional insurance products. Following are the benefits of having parametric insurance:
- Payouts: The payout of claims are processed faster as compared to traditional insurances which may take months due to the nature of the insurance.
- Customization: Parametric insurance can be customized as preferred by different individuals while traditional insurances have many limitations.
- Guaranteed payout: Once the predetermined parameter has been reached due to the occurrence of triggering event and conditions are met, the payment will be made despite suffering no damages.
Protection range: Parametric insurances provide a wider range of protection to a policyholder as compared to traditional insurance due to the insurance structure.