Triggering index-based insurance

Para­met­ric insur­ance is gain­ing trac­tion as a prag­mat­ic way to cov­er pre­vi­ous­ly unin­sur­able risks dur­ing times of cat­a­clysmic change. Instead of pay­ing a claim based on the val­ue of the loss incurred, it pays out auto­mat­i­cal­ly when an event mea­sured by a pre-agreed trig­ger occurs.

While not entire­ly new, para­met­ric or index-based prod­ucts are gain­ing rel­e­vance in a world beset by fre­quent­ly-occur­ring and extreme events, and one which is increas­ing­ly mea­sured, mon­i­tored and quan­ti­fied by data.

An improved cus­tomer expe­ri­ence, com­bin­ing speed and cer­tain­ty, is a big part of its appeal and reflects the dig­i­tal­ly con­nect­ed world we inhab­it. The propo­si­tion of an imme­di­ate and fric­tion­less pay­out com­pares well with the cum­ber­some process admin­is­tered by adju­di­ca­tors and lit­i­ga­tors in tra­di­tion­al insur­ance.

Prov­ing the point, dig­i­tal star­tups are cater­ing for con­sumers who want to cov­er the risk of a can­celled flight, or not enough snow on their ski­ing hol­i­day, and who want com­pen­sa­tion now.

Com­pa­nies such as Flood­Flash, Blink, Sky­line Part­ners and Setoo are har­ness­ing the propo­si­tion of supe­ri­or cus­tomer expe­ri­ence and devel­op­ing prod­ucts cov­er­ing cli­mate, ener­gy, util­i­ties and trav­el risk. Let­ting cus­tomers select the pro­tec­tions they want, using objec­tive data sources to crunch pre­mi­ums in real time, and guar­an­tee­ing fast pay­ment through auto­mat­ed con­tracts, com­bine to make a win­ning for­mu­la.

“We believe that every time a con­sumer buys some­thing online there is a con­cern and this is cur­rent­ly not being dealt with”, says Noam Shapi­ra, co-founder of Setoo.

Fast and assured pay out improves customer experience

This sen­ti­ment could eas­i­ly apply to oth­er areas of insur­ance and the model’s poten­tial to play a wider role in a data-dri­ven uni­verse is sig­nalled by InsTech London’s report Para­met­ric Insur­ance: 2021 out­look and the com­pa­nies to watch.

“Para­met­ric insur­ance is start­ing to offer attrac­tive solu­tions where con­ven­tion­al insur­ance has failed,” says the report’s co-author, Matthew Grant, part­ner at the InsTech Lon­don. “Tech­nol­o­gy exists to define and deliv­er insur­ance cov­er­age based on real-time report­ing of accu­rate data.”

Swiss Re esti­mates of tra­di­tion­al insur­ance cov­er­ing only 40 per cent of around $140 bil­lion of eco­nom­ic loss­es from nat­ur­al and man-made dis­as­ters in 2019 give cre­dence to Grant’s view­point. And coro­n­avirus has jump-start­ed the debate about the role para­met­ric insur­ance can play in assess­ing emerg­ing risk and quan­ti­fy­ing loss on a warm­ing plan­et and volatile world.

“The pan­dem­ic demon­strat­ed one of many ways that busi­ness­es can be inter­rupt­ed with­out direct phys­i­cal dam­age. This is rel­e­vant because para­met­ric insur­ance allows for much broad­er “non-phys­i­cal dam­age” busi­ness inter­rup­tion cov­er­age, so long as it is still asso­ci­at­ed with an objec­tive and mea­sur­able event,” explains Peter Laco­vara, senior vice pres­i­dent and alter­na­tive risk trans­fer leader at Marsh bro­ker­age.

Parametric policies plug insurance gaps

Simon Young, senior direc­tor at Willis Tow­ers Wat­son, points out that video footage from Wuhan in Chi­na, epi­cen­tre of COVID-19, con­sti­tut­ed mea­sur­able data that could have been used to indi­cate risk. “CCTV from last autumn showed Wuhan hos­pi­tal car parks fill­ing up, an ear­ly sign of a med­ical cri­sis unfold­ing,” he says.

Inter­est­ing­ly, a para­met­ric pol­i­cy – Pathogen­RX, devel­oped by Marsh, Munich Re and tech­nol­o­gy firm Metabio­ta, and trig­gered by mor­tal­i­ty or infec­tion rates – did pro­vide cov­er for a pan­dem­ic, but no one bought it.

Young says there’s poor under­stand­ing of para­met­ric insur­ance and a realign­ment of expec­ta­tions is need­ed to realise its poten­tial. “Peo­ple con­fuse it with indem­ni­fi­ca­tion,” he says. “If you make it clear that it’s not equiv­a­lent, it could actu­al­ly raise trust lev­els.”

Laco­vara con­curs: “Para­met­rics are com­plex prod­ucts, even to pro­fes­sion­als, so find­ing a way to make them acces­si­ble to the aver­age buy­er will be an impor­tant part of the sto­ry.”

For now, para­met­ric insur­ance is estab­lished in agribusi­ness and cat­a­stro­phe rein­sur­ance where trig­gers are rel­a­tive­ly easy to define. But the rapid growth of the inter­net of things and data cap­ture will pro­vide more and nov­el oppor­tu­ni­ties to cre­ate para­me­ters that are prox­ies for under­ly­ing risk.

“In prin­ci­ple, para­met­ric could play a role, but every­thing depends on whether it’s pos­si­ble to iden­ti­fy a suit­able para­me­ter that describes the risk,” says Rain­er Hart­mann, head of agrisk part­ners at Munich Re.

More broad­ly, the insur­ance val­ue chain is embrac­ing dig­i­tal tech­nol­o­gy and ver­i­fi­able data that speed up trans­ac­tions and add cer­tain­ty, shoring up trust and cus­tomer expe­ri­ence. Blockchain, a dis­trib­uted, immutable ledger, is stream­lin­ing dis­pute res­o­lu­tion, which cur­rent­ly costs the sec­tor $9 bil­lion a year.

Objective data shores up trust

Proof of Trust’s blockchain spins up anonymised adju­di­ca­tion pan­els, set­tling dis­putes faster for clients and releas­ing cap­i­tal back to insur­ers. Apply­ing data ana­lyt­ics to the dis­pute res­o­lu­tion life cycle also yields valu­able insights, which can be shared by all par­ties, accord­ing to Sakhib Waseem, chief inno­va­tion offi­cer at Proof of Trust.

Insur­ance con­sor­tia RiskStream and B3i use blockchain’s trust prop­er­ties to reduce fric­tion and strip out cost in trans­ac­tions between bro­ker, insur­er and rein­sur­er mem­bers. Automa­tion low­ers the cost of pro­cess­ing and makes pos­si­ble the insur­ance of risks that were pre­vi­ous­ly uneco­nom­i­cal.

David Rut­ter, founder and chief exec­u­tive of blockchain provider R3, says the dis­trib­uted ledger tech­nol­o­gy is par­tic­u­lar­ly apt for para­met­ric insur­ance and its trust prop­er­ties improve cus­tomer expe­ri­ence. “It pro­vides data prove­nance and the cer­tain­ty that data comes from an approved par­ty,” he says. “The use of smart con­tracts assures that appro­pri­ate data was added at the right time accord­ing to pre-agreed for­mu­lae.”

Para­met­ric insur­ance may still be in its infan­cy, but using mea­sur­able para­me­ters twinned with auto­mat­ic pay­ment is a strong suit in an increas­ing­ly data-dri­ven world. As Paul Ridge, head of insur­ance at SAS UK and Ire­land, con­cludes: “Tech­nol­o­gy and data have a grow­ing influ­ence on the abil­i­ty to either price the risk, trans­fer it or, ulti­mate­ly, pre­vent it.”

Para­met­ric insur­ance may still be in its infan­cy, but using mea­sur­able para­me­ters twinned with auto­mat­ic pay­ment is a strong suit in an increas­ing­ly data-dri­ven world. As Paul Ridge, head of insur­ance at SAS UK and Ire­land, con­cludes: “Tech­nol­o­gy and data have a grow­ing influ­ence on the abil­i­ty to either price the risk, trans­fer it or, ulti­mate­ly, pre­vent it.”

Farming: exemplar for parametric practice

Para­met­ric insur­ance is a good fit with agri­cul­ture because the phys­i­cal nature of the envi­ron­ment and work mean risks like flood and drought are vis­i­ble and mea­sur­able. “By nature, farm­ers are inher­ent­ly good risk man­agers. They applied risk-mit­i­gat­ing strate­gies before insur­ance was ever avail­able, using tech­niques such as crop rota­tions to spread risk,” says Rain­er Hart­mann, head of agrisk part­ners at Munich Re.

A para­met­ric solu­tion has rel­e­vance for the entire food pro­duc­tion val­ue chain, which is impact­ed by the same risk, but in dif­fer­ent ways. The farmer, trad­ing com­pa­ny and logis­tics firm are all impact­ed by the same risk – crop short­fall – because of exces­sive rain or drought and so this impacts the entire val­ue chain. A farmer can’t repay loans or buy seed for next sea­son, the logis­tics com­pa­ny has no trans­porta­tion cus­tom and the food proces­sor can’t ful­fil cus­tomers’ orders.

The grow­ing use of data and dig­i­tal tech­nol­o­gy in farm­ing prac­tices puts the sec­tor in a sweet spot for para­met­ric insur­ance. Farm­ers are using smart farm­ing and col­lect data about the per­for­mance of their crop and their machin­ery, and access and share data on crop yields from satel­lite imag­ing. “It’s a nat­ur­al step to use this data ana­lyt­ics to struc­ture risk trans­fer solu­tions,” says Hart­mann.