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Parametric Insurance Explained
Parametric insurance can be a particularly beneficial form of coverage to have in the scope of large-scale natural disasters, especially when not all associated losses entail physical damages. Yet, there are some additional aspects of this coverage offering to consider.

Home » Business Insurance » Parametric Insurance Explained

Parametric Insurance Explained

Parametric insurance can be a particularly beneficial form of coverage to have in the scope of large-scale natural disasters, especially when not all associated losses entail physical damages. Yet, there are some additional aspects of this coverage offering to consider.
Contrary to the reimbursement method of standard commercial policies, parametric insurance offers protection based on a predetermined, measurable characteristic tied to a covered event. Under such coverage, the amount a policyholder is compensated isn’t decided by the exact cost of damages sustained but rather by the calculated intensity of the covered event itself. For instance, if a hurricane caused damage to a commercial property, a parametric policy might reimburse a set dollar amount linked to the storm’s wind speeds.

Parametric insurance can be a particularly beneficial form of coverage in large-scale natural disasters, especially when not all associated losses entail physical damages. Yet, there are some additional aspects of this coverage offering to consider. Review the following guidance to gain a better understanding of parametric insurance.

 

How Parametric Insurance Works

To fully comprehend how a parametric policy works, one must first consider how standard commercial insurance coverage operates. Following a covered event, traditional policies typically reimburse the exact cost of the resulting damages.

For example, if a fire destroyed a business’s building, the business’s commercial property policy would likely compensate the precise amount of funds needed to restore the building. This amount is often determined by a loss adjuster, who carefully assesses the overall expenses stemming from an event accurately.

On the other hand, Parametric insurance does not focus on the physical damages incurred from a covered event. Instead, reimbursement is based on the severity of the actual event. Potential indicators of a covered event’s intensity—also known as triggers—must be independently verifiable, relatively simple to measure following the event, and adequately representative of potential losses that could arise from such a disaster.

Some covered events only need one trigger to activate policy reimbursement, while others require multiple. Common triggers include floodwater height, hurricane wind speed, and earthquake magnitude. As such, a commercial property’s parametric policy could be set up to provide a set payout amount if the property experiences an earthquake above a magnitude of 5.1 on the Richter scale.

Further, parametric coverage can increase payouts as a covered event intensifies. In this scenario, the set payout amount for a magnitude 7.5 earthquake could be more significant than that of a magnitude 5.5 earthquake—such as 75% of the policy limit versus 50% of the policy limit, respectively.

 

Benefits of Parametric Insurance

Recent years have seen a sharp rise in the frequency and severity of natural disasters across the country. Between raging wildfires on the West Coast, severe tornadoes across the Midwest, and devastating hurricanes throughout much of the Southeastern states, more and more businesses are encountering the costly consequences of large-scale natural disasters.

What’s worse, climate experts predict that these disasters will only continue to increase in the years to come—making them an ongoing concern for many business owners. With this in mind, parametric insurance can be an advantageous form of coverage for any business in an area prone to specific weather events. In addition, parametric insurance can also offer the following key benefits:

 

  • Timely payouts—Because traditional policies cover the exact cost of loss from an event, policyholders won’t receive their payout until the loss adjuster has fully assessed the damages and determined an accurate reimbursement amount with the insurance carrier be a long process. However, since parametric policies already have predetermined reimbursement amounts based on event severity, such policyholders are more likely to receive fast payouts after a covered event.
  • Increased flexibility and customization—While standard policies don’t always provide much room for customization, parametric coverage is far more flexible. The main features of this insurance—namely, the trigger details and set payout structures—can be specifically designed to meet the policyholder’s unique needs.
  • Coverage possibilities—Lastly, the payout method utilized within parametric policies often allows for expanded coverage capabilities. Instead of the reimbursement amount being automatically designated to a specific expense (e.g., the cost of repairing the property’s roof), policyholders can use their judgment to determine how to make the most use of their payout. This freedom permits policyholders to spend their reimbursement funds on loss elements that aren’t necessarily physical or outwardly evident (e.g., business interruption concerns).

 

Additional Considerations

Despite the benefits of parametric insurance, some additional coverage considerations must be considered. First, parametric policies are always accompanied by some degree of basis risk. This refers to the possibility that the pre-established reimbursement amounts for different covered events may not end up fully covering the total cost of damages that the policyholder incurs.

While basis risk can be present in any commercial policy, it is widespread within parametric policies that lack thoughtful trigger details and payout structures. To minimize this concern, it’s critical to consult your insurance carrier and trusted broker to ensure you fully understand your policy’s structure and possess adequate coverage for your particular exposures.

Second, parametric insurance can sometimes be more expensive than a traditional coverage. Although such contrasting policy conditions make it complicated to compare prices between standard and parametric insurance, the latter form of coverage can be accompanied by elevated premium costs when the payout structure allows for a wide range of protection.

Finally, most parametric policies contain what’s known as a proof-of-loss requirement. This means that even though the severity of the covered event will determine the reimbursement amount, the policyholder must still submit some form of evidence that proves they experienced a loss from the event to receive a payout. Such a requirement removes the risk of policyholders unaffected by an event fraudulently receiving reimbursement. To ensure the payout process runs smoothly and efficiently, it’s crucial to have a plan in place for providing proof of a loss after a covered event (e.g., taking pictures of damages and saving receipts).

Contrary to the reimbursement method of standard commercial policies, parametric insurance offers protection based on a predetermined, measurable characteristic tied to a covered event. Under such coverage, the amount a policyholder is compensated isn’t decided by the exact cost of damages sustained but rather by the calculated intensity of the covered event itself. For instance, if a hurricane caused damage to a commercial property, a parametric policy might reimburse a set dollar amount linked to the storm’s wind speeds.

Parametric insurance can be a particularly beneficial form of coverage in large-scale natural disasters, especially when not all associated losses entail physical damages. Yet, there are some additional aspects of this coverage offering to consider. Review the following guidance to gain a better understanding of parametric insurance.

 

How Parametric Insurance Works

To fully comprehend how a parametric policy works, one must first consider how standard commercial insurance coverage operates. Following a covered event, traditional policies typically reimburse the exact cost of the resulting damages.

For example, if a fire destroyed a business’s building, the business’s commercial property policy would likely compensate the precise amount of funds needed to restore the building. This amount is often determined by a loss adjuster, who carefully assesses the overall expenses stemming from an event accurately.

On the other hand, Parametric insurance does not focus on the physical damages incurred from a covered event. Instead, reimbursement is based on the severity of the actual event. Potential indicators of a covered event’s intensity—also known as triggers—must be independently verifiable, relatively simple to measure following the event, and adequately representative of potential losses that could arise from such a disaster.

Some covered events only need one trigger to activate policy reimbursement, while others require multiple. Common triggers include floodwater height, hurricane wind speed, and earthquake magnitude. As such, a commercial property’s parametric policy could be set up to provide a set payout amount if the property experiences an earthquake above a magnitude of 5.1 on the Richter scale.

Further, parametric coverage can increase payouts as a covered event intensifies. In this scenario, the set payout amount for a magnitude 7.5 earthquake could be more significant than that of a magnitude 5.5 earthquake—such as 75% of the policy limit versus 50% of the policy limit, respectively.

 

Benefits of Parametric Insurance

Recent years have seen a sharp rise in the frequency and severity of natural disasters across the country. Between raging wildfires on the West Coast, severe tornadoes across the Midwest, and devastating hurricanes throughout much of the Southeastern states, more and more businesses are encountering the costly consequences of large-scale natural disasters.

What’s worse, climate experts predict that these disasters will only continue to increase in the years to come—making them an ongoing concern for many business owners. With this in mind, parametric insurance can be an advantageous form of coverage for any business in an area prone to specific weather events. In addition, parametric insurance can also offer the following key benefits:

 

  • Timely payouts—Because traditional policies cover the exact cost of loss from an event, policyholders won’t receive their payout until the loss adjuster has fully assessed the damages and determined an accurate reimbursement amount with the insurance carrier be a long process. However, since parametric policies already have predetermined reimbursement amounts based on event severity, such policyholders are more likely to receive fast payouts after a covered event.
  • Increased flexibility and customization—While standard policies don’t always provide much room for customization, parametric coverage is far more flexible. The main features of this insurance—namely, the trigger details and set payout structures—can be specifically designed to meet the policyholder’s unique needs.
  • Coverage possibilities—Lastly, the payout method utilized within parametric policies often allows for expanded coverage capabilities. Instead of the reimbursement amount being automatically designated to a specific expense (e.g., the cost of repairing the property’s roof), policyholders can use their judgment to determine how to make the most use of their payout. This freedom permits policyholders to spend their reimbursement funds on loss elements that aren’t necessarily physical or outwardly evident (e.g., business interruption concerns).

 

Additional Considerations

Despite the benefits of parametric insurance, some additional coverage considerations must be considered. First, parametric policies are always accompanied by some degree of basis risk. This refers to the possibility that the pre-established reimbursement amounts for different covered events may not end up fully covering the total cost of damages that the policyholder incurs.

While basis risk can be present in any commercial policy, it is widespread within parametric policies that lack thoughtful trigger details and payout structures. To minimize this concern, it’s critical to consult your insurance carrier and trusted broker to ensure you fully understand your policy’s structure and possess adequate coverage for your particular exposures.

Second, parametric insurance can sometimes be more expensive than a traditional coverage. Although such contrasting policy conditions make it complicated to compare prices between standard and parametric insurance, the latter form of coverage can be accompanied by elevated premium costs when the payout structure allows for a wide range of protection.

Finally, most parametric policies contain what’s known as a proof-of-loss requirement. This means that even though the severity of the covered event will determine the reimbursement amount, the policyholder must still submit some form of evidence that proves they experienced a loss from the event to receive a payout. Such a requirement removes the risk of policyholders unaffected by an event fraudulently receiving reimbursement. To ensure the payout process runs smoothly and efficiently, it’s crucial to have a plan in place for providing proof of a loss after a covered event (e.g., taking pictures of damages and saving receipts).

The Last Word

For more information about parametric insurance, or help in protecting your business from large-scale natural disasters, contact an InsureGood Advisor today.

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