Innovating the Product Landscape with Parametric Insurance
In our blog Parametric insurance, delighting customers and carriers, we explained how this type of insurance, also called index-based, charms customers and carriers by offering them a simpler and more streamlined experience than traditional insurance. A straightforward “IF-THEN” type contract, stripped from complex wording, will trigger an (almost) immediate payment of claim if and when an insured event reaches or exceeds predetermined values of a given parameter. What are the factors that drive parametric insurance (PI) forward and how does it contribute to developing the market is what we here wish to elucidate further.
On top of favourably resolving the drawbacks of traditional insurance with regards to the specificities of its processes – risk assessment, contract wording, and claim management – covered in the blog post mentioned above, PI innovates and provides protection where traditional insurance stops.
In hard markets, clients strive to get insured or simply cannot because of carriers’ refusal to cover a peril at a “normal” price. Such is the case with climate risks, following the increase in natural disasters and extreme weather events. The coverage insurers are willing to provide is getting narrower, and the supply of insurance becoming lower, which ultimately leads to spikes in insurance costs.
Traditionally insurance is designed to repair the material or physical damage caused by an event. Nevertheless, some do not produce material damage but lead to operational loss. Such is the case with business interruption originated by pandemics or dysfunctions in the supply chain, for instance. Traditional insurance dogma is therefore limited and simply not fit for purpose.
A third case in which parametric insurance has provided a solution for protection is microinsurance. To be profitable, these small-scale insurance policies offered in developing markets must have low administrative costs related to the claims adjustment process, which traditional indemnity policies cannot offer.
While parametric insurance has traditionally been used for protection against natural catastrophes, new sources of data are now enabling more types of parametric coverage. Advances in technology and data collection are empowering it. High-quality, granular data means we can track events better than ever before while helping to improve our understanding of perils.
Once the ‘parameters’ are agreed upon, cutting-edge technologies are employed to monitor how things evolve around the indexes. To monitor the on-site threats and see if the threshold is met in near real-time, data sources such as IoT, satellite imagery, stationary sensor, radar, or sonar data, are installed in the insured area or collected from open sources such as public authorities and agencies.
While allowing the monitoring of threats related to specific contracts, data collection further contributes to building knowledge. Combined with machine learning algorithms, image recognition techniques, and advanced statistics, the data is interpreted to generate new or update existing models. In doing so, insurers may create parameters that are proxies for underlying risks.
The travel and holiday industry is one of the scenes where innovation related to index-based insurance has been significant. In 2019 the insurtechs Wakam and Koala partnered to provide flight delay and cancellation insurance embedded in airlines booking websites. By doing so, customers could choose to add insurance at the point of purchase, with their chosen level of compensation for delays. Connected to live flight information, Koala uses it as a parametric trigger to automatically pay out a defined financial compensation when a customer’s flight is delayed or cancelled. In 2021, Wakam would replicate with Setoo (now Pattern Insurance) to design and launch a similar cover for ferry delays and cancellations in Greece.
The Blink Lost Luggage product uses parametric technology to offer real-time financial compensation to airline passengers whose checked luggage cannot be located following an airport arrival.
Arbol designed a weather protection program for vacation rentals. If it rains for more than half of the holiday, the renter is refunded their selected coverage amount. Another product of Pattern Insurance is a policy that reimburses skiers for poor snow conditions on their vacation.
In risks related to the climate, Flood Flash in England achieved a record payout time of under 10 hours following a flood that triggered the parametric cover in 20213. Descartes Underwriting is another example who designed a parametric hailstorm cover for a solar energy plant that traditional insurers refused to cover following the occurrence of a claim.
Of all areas and technologies creating new opportunities for the expansion of parametric insurance, Web 3.0 and distributed ledger technology (DLT) – and more specifically the blockchain – are perhaps the ones presenting the most potential. There is a natural connection between parametric insurance and DLT, especially when considering smart contracts. Smart contracts enable automatic, immediate transactions that are independently verified without the need for third parties to do so. The automatic payments built into parametric insurance require trusted data sources and secure transactions. DLT and smart contracts ensure this trust while automating the payment and speeding up the process even further.
It is blockchain technology that GoodsID uses in the theft insurance solution for engagement rings that Wakam set up for the jewellery brand Courbet. In case a client logs a theft within two years and the report is validated, Courbet automatically starts to produce an identical replacement for the customer.
To engage effectively in parametric insurance carriers need to harmonise a value chain where a series of stakeholders are called to intervene. Historical data only not being enough to predict the probability a new or changing risk occurs, one must understand its underlying factors as well as find the appropriate sources of measurement. In climate risk, for instance, to design a frost protection parametric insurance for vineyards valid in the month of April, the client, his broker, a specialist in viticulture and the insurer need to collaborate. Occasional frost in April being normal, a specialist in viticulture will explain why today, due to climate change, vineyards in some years suffer more. The client’s master of culture will share how much of the grape is destroyed if the temperature falls to -1ºc, -1,5ºc or -2ºc. Together they will eventually come up with a parametric contract defining a specific pay-out corresponding to 10%, 15% or 20% of production if the temperature in the vineyard (measured by meteorological stations placed by the insurer) falls to -1ºc, -1,5ºc or -2ºc respectively, in April.
This example shows the capabilities that are necessary to come up with the appropriate parameters, that need to be reflected on, modelled, and calculated to become exploitable insurance data. As appropriate, brokers may then participate in the popularization of cover and price the risk with the client.
Next to the fluidity and communication that is needed between all stakeholders, technology plays a central role – see the illustration below. To propose parametric insurance to their clients and offer them a seamless experience similar to that of digital leaders such as Lemonade, Uber and Trov, insurers must adopt modern software architecture. Modular solutions that include API-based functionalities (external, internal and data APIs) may then consume structured/unstructured data, facilitate transactions in real-time and leverage AI engines built around machine learning.
Parametric insurance is growing and will continue to do so, limited only by risk professionals’ creativity and access to meaningful data. As aerial imagery, sensors, connected devices and other technologies continue to become more sophisticated, they create newer and more accurate streams of data to be used for analysis and application. This new wave of insurance products being very technological, to design, set up and manage game-changing products and delight their customers, insurers need adequate IT technology. Modern insurance platforms provide them with the necessary capabilities that will permit them to do so and reap the benefits of a promising movement in products.
. Wakam’s embedded parametric solutions for travel insurance, POSTED ON JULY 21, 2021 BY INSIGHT. HENRY GALE, From <https://www.instech.co/insight/wakams-embedded-parametric-solutions-travel-insurance>
. Parametric Insurance Is a Tonic for Insurers and Their Customers, From https://u.plus/insights/parametric-insurance-is-a-tonic-for-insurers-and-their-customers#parametric-insurance-is-a-tonic-for-insurers-and-their-customers
. Risque Climatique : un enjeu majeur pour l’Assurance ? Jeudi 16 février 2023 – 12h00 (WET), https://www.youtube.com/watch?v=ZuyCluINlyc
. Cognizant 20-20 Insights, How APAC Insurers Can Modernize with Next-Gen Digital Policy Administration Systems, Jan. 2020