Parametric disaster insurance

December 6, 2023

In today’s rapidly changing world, traditional insurance products may fall short when it comes to effectively managing and mitigating risk. However, to fill those voids a new type of insurance product has emerged—parametric insurance.

Parametric insurance covers the probability of a predefined event occurring instead of indemnifying the actual loss or damage incurred. The practical effect of this means that upon the occurrence of a triggering event—such as wind speed, rainfall, or earthquake—an insurer will pay a policyholder a set amount of money based on the magnitude of the triggering event, not the magnitude of the losses or damages.

As climate change-related natural disasters continue to occur more frequently and unpredictably, the damages and losses that these storms inflict will become more expensive to insure as well. According to the National Oceanic and Atmospheric Administration, since 1980, the United States has sustained 357 weather and climate disasters where the overall costs exceeded $2.565 trillion.[1]

If history is a good indicator of the future, that dollar figure is only expected to grow as our planet continues to warm and extreme weather persists. By way of example, let’s examine the development of parametric insurance in Puerto Rico following the aftermath of Hurricanes Irma and Maria, as well as explore the benefits that this innovative insurance product has to offer.

Puerto Rico

Hurricane Irma and Hurricane Maria had devastating effects on Puerto Rico. In September 2017, Hurricane Irma, a powerful Category 5 storm, pummeled the island, causing widespread power outages, damage to infrastructure, and limited access to food, water and medicine. Just two weeks later, Hurricane Maria made landfall. Maria, a Category 5 hurricane, unleashed catastrophic winds, torrential downpours, and severe flooding across Puerto Rico. The impacts were staggering, leading to a humanitarian crisis and long-term economic consequences for the island, including recovery and rebuilding efforts, which were a challenging process, requiring extensive assistance from the United States, its businesses and international organizations. The effects of Hurricane Irma and Hurricane Maria served as a stark reminder of the destructive power of hurricanes and the need for preparedness, resilience, and timely assistance in the wake of these catastrophic storms.

In July 2020, Puerto Rico heeded that warning and adopted Rule 103,[2] a regulation to establish a regulatory framework for parametric microinsurance products with low-cost premiums intended for low-income families. This made Puerto Rico the first U.S. state or territory to authorize parametric insurance products. The objective of the regulation was three-fold.

First, it aimed to reduce Puerto Rico’s reliance on the Federal Emergency Management Agency by offering diversified insurance coverage in the form of parametric insurance against predefined events.

Second, the regulation aimed to offer affordable microinsurance products to businesses and families on the island.

Lastly, Rule 103 sought to improve Puerto Rico’s resiliency in the wake of Irma and Maria. Three years later—in July 2023—AON, a global professional services firm, announced the establishment of a parametric insurance program built for the government of Puerto Rico,[3] to provide the island with swift access to liquid capital during the aftermath of a triggering event, like an earthquake or hurricane.

With hurricane season set to end at the end of this month, and the recent establishment of the aforementioned parametric insurance program in Puerto Rico, it is certain that the insurance industry will monitor the island closely to assess the performance and effectiveness of the parametric insurance market. To assess, we will navigate the benefits parametric insurance can offer its customers prospectively.

Expedited and predictable compensation

Parametric insurance is an innovative insurance product that provides faster and more predictable compensation to policyholders. Unlike traditional insurance policies that rely on complex claims processes and extensive investigations, parametric insurance does not require proof-of-loss or damages to initiate compensation, instead compensation is triggered automatically when a natural disaster exceeds a predefined threshold, allowing for money to get into the hands of the customers who need it. Further, because the triggering events are predefined, the compensation amount is more predictable than in traditional insurance policies in which the payout amount can be affected by factors like the cost of repairs and the value of the property. This makes parametric insurance an attractive option for individuals and businesses looking for fast and reliable compensation in the event of unforeseen events.

Customizable coverage

In contrast to traditional insurance policies that provide a predetermined coverage amount, parametric insurance policies offer policyholders the ability to personalize their coverage according to their specific needs and risks. This customization not only offers increased flexibility but makes parametric insurance an appealing option as policyholders only pay for the specific coverage they need—making it a more valuable and cost-effective choice compared to traditional insurance policies.

Greater transparency

Parametric insurance provides enhanced transparency to the insurance industry by utilizing objective, predefined parameters to determine compensation, instead of subjective assessments of damages. The increased transparency of parametric insurance benefits both insurers and policyholders by reducing uncertainty about compensation and promoting a more efficient insurance marketplace.

Gulf states

Parametric insurance has been trialed in the United States in Alabama, Louisiana, and Miami-Dade County in Florida. Reinsurer Swiss Re spearheaded parametric insurance programs in all three locations. The first program began in 2010, covering Alabama State Insurance Fund’s hurricane risk for three years.[4] In 2019, both Louisiana and Miami-Dade County entered similar deals valued at $1.25 million for winds of 80 mph for at least a minute, and $10 million for wind speeds over 87.5 mph, respectively.[5]

As the growing threat of catastrophic disasters persists, will state and local governments seek to invest in this unique insurance product? Only time will tell whether parametric insurance can be the next solution to manage and mitigate the ever-increasing dangers of life on coastline communities effectively.

This article originally appeared in the November 2023 issue of PIA Magazine.

[1] NOAA, 2023

[2] Government of Puerto Rico, 2020

[3] Insurtech Insights

[4] PreventionWeb, 2010

[5] Ibid.

Theophilus Alexander
PIA Northeast

Theophilus W. Alexander joined PIA Northeast as a government & industry affairs specialist for the Government & Industry Affairs Department in 2023. Prior to joining PIA, Theo had served in both houses of the New York State Legislature. Previously, he worked as a legislative analyst for Hon. New York State Sen. Samra G. Brouk, D-55, and he served at the New York State Assembly, as a policy analyst with New York Assembly Program & Counsel. Theo received his Bachelor of Arts degree in Politics from Ithaca College in Ithaca, N.Y.

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