Using an alternative method to conventional insurance models for terms of coverage, parametric insurance offers a solution for specific hard-to-place risk exposures. Instead of compensating for actual losses or damages, parametric insurance uses defined parameters and objective data for nominated risks to trigger predetermined payouts when specific conditions are recorded. Here we present some examples of how parametric insurance can be applied and how it can open up a new avenue for risk coverage and provide significant benefits to both insurer and customer.

When can parametric insurance be used?

Parametric insurance has a wide range of applications across a range of industries. Natural catastrophes or extreme weather events are currently the most prevalent triggers as they can be defined by magnitude — such as earthquakes, tropical cyclones, floods — or wind speed or precipitation metrics.

The key criteria for an insurable trigger are that it's fortuitous and it can be modelled:

Here are some examples of parametric applications.

Weather and natural catastrophe-related perils

  • Cyclone: Parametric insurance can provide cover for businesses located in hurricane-prone regions, where payouts are triggered by pre-agreed wind velocity during a storm.
  • Flood: Parametric insurance can be used to protect businesses against losses caused by floods, with triggers based on water levels or rainfall thresholds.
  • Drought: Parametric coverage can help agricultural businesses mitigate the financial impact of droughts, with payouts triggered by specific temperature, precipitation or soil moisture levels.
  • Hail: Parametric insurance can be used to protect against property and/or crop damage by using Bureau of Meteorology (BOM) data recording size and density of hailstones.
  • Earthquake: Parametric insurance has potential to be used to provide cover for damage and losses by using location based measurement of severity on the Richter scale.
  • Bushfire: For forestry and similar plantations, parametric insurance can be used to compensate for lost yields using measurements of the area under cultivation (percentage of land burned) and the latitude-longitude coordinates of the fire's impact in that location.

Agriculture and forestry

  • Yield protection: Parametric insurance can provide coverage for farmers against low crop yields caused by adverse weather conditions, such as excessive heat, frost or insufficient rainfall.
  • Livestock mortality: Parametric coverage can protect livestock farmers by triggering payouts based on temperature extremes or other parameters that increase the risk of animal mortality.

Energy and utilities

  • Wind yield: Parametric coverage can be used to protect wind energy producers against reduced wind speeds, with payouts triggered when wind yield falls below a certain threshold.
  • Solar yield: Parametric insurance can safeguard solar energy projects by providing compensation when solar radiation levels drop below predetermined levels, impacting energy production.
  • Hydropower: Parametric coverage can be designed to protect hydropower facilities against low water levels or insufficient flow rates, which can impact power generation.

Other exposures that can be covered by parametric insurance

  • Non-damage business interruption: Parametric insurance can cover businesses that rely on specific suppliers or key infrastructure by triggering payouts when predefined events, such as port closures or transportation disruptions, occur.
  • Construction delay: Parametric coverage can protect construction projects against delays caused by extreme weather conditions, triggering payouts when predetermined weather thresholds are exceeded.
  • Supply chain hold-ups: Where access to routes, storage hubs and ports has been prevented by external factors such as fire or flooding, the metrics from these events and the locations affected can be used in the provision of parametric insurance cover.

These examples demonstrate how parametric insurance can be customised to suit different industries and specific risks. The flexibility of parametric coverage allows businesses to address gaps in traditional insurance policies, mitigate financial losses, and enhance their resilience to the impact of foreseeable events.

Advantages of parametric insurance

  • Tailored coverage for foreseeable events and payout amounts decided by the business according to their exposure to particular perils and their likely impacts.
  • Efficiencies of claims. Policies usually stipulate a prompt claim payment — without any loss adjustment process required. This streamlined approach ensures faster access to funds, enabling faster recovery to resume operations.
  • No onerous requirements such as site assets inventory or engineering certification required prior to policy inception.
  • Transparency of policy terms which are not restricted by sub-limits or exclusions, removing the possibility of coverage disputes on claims.

While parametric cover provides an alternative solution in many circumstances it is dependent on existing infrastructure that collects data to enable nominating a recorded trigger metric — and in some cases the historical data may not provide the information required.

Also, your nominated sum insured to be paid if the trigger metric is reached may not meet or match the financial loss you sustain, or you might sustain losses without even meeting the trigger point.

Parametric cover also includes financial impacts, such as business interruption and/or additional costs of working, caused by the insured peril, without the need for proof of property damage.

In addition to helping businesses meet a wide range of longer term costs, funds can also be used for risk mitigation and improving resilience to future events.

How we can help you with parametric insurance solutions

Working with an insurance broker to understand your business exposures can help you to identify the right solutions to mitigate your risks.

Talk to us about the viability of a parametric solution for your risks.

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Gallagher provides insurance, risk management and benefits consulting services for clients in response to both known and unknown risk exposures. When providing analysis and recommendations regarding potential insurance coverage, potential claims and/or operational strategy in response to national emergencies (including health crises), we do so from an insurance and/or risk management perspective, and offer broad information about risk mitigation, loss control strategy and potential claim exposures. We have prepared this commentary and other news alerts for general information purposes only and the material is not intended to be, nor should it be interpreted as, legal or client-specific risk management advice. General insurance descriptions contained herein do not include complete insurance policy definitions, terms and/or conditions, and should not be relied on for coverage interpretation. The information may not include current governmental or insurance developments, is provided without knowledge of the individual recipient's industry or specific business or coverage circumstances, and in no way reflects or promises to provide insurance coverage outcomes that only insurance carriers' control.

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