Alternative risk transfer options, including parametric insurance, find their way onto the board’s agenda when traditional cover falls short leaving an uninsured loss or through high cost, limited capacity, or simply not being able to solve the business problem at hand.
However, getting approval for alternative solutions like parametric insurance can hit stumbling blocks around costs and perception of value.
If you think parametric insurance could be a valuable strand of your risk finance strategy but are struggling to persuade business leaders, then this insight can help. It covers how parametric insurance works, why your organization might need to consider it and how to best highlight the benefits and explain the costs to decision-makers.
How does parametric insurance work?
Parametric insurance responds when an event occurs with a pre-agreed severity. For floods, this trigger might be river height, tidal data or an on-site water sensor. When certain thresholds are met, a predefined payout is readied, with payment released as soon as the insured warrants the size of the loss suffered. This process is completed in days as opposed to lengthier and potentially less certain assessments of physical damage.
These funds can then be used to satisfy any form of loss. While in the main, this is likely to be property damage, extra expenses or business interruption, it can in fact be any form of loss incurred. This could be: losses from assets not covered by a property policy, costs incurred in supporting impacted employees, or reduction in revenue from loss of attraction.
Why might your organization need to consider parametric insurance?
Parametric insurance can enter the conversation when your business needs a quick payout and can't afford to wait for loss adjustment, when non-damage business interruption sits outside standard cover, or when exclusions and sub-limits leave too much of the real financial exposure with you.
Traditional cover may be too slow to pay claims or have exclusions that reduce the quality of cover. Risk and finance leaders may also realize standard cover may not reflect the complex realities of how natural catastrophe or climate-driven risks would disrupt your operations.
How can you best explain the cost of parametric insurance to decision-makers?
We accept that cost is often an objection when considering parametric insurance, especially when business leaders compare premiums to average historic payouts or a property policy and stop there. Often the comparison wasn’t like-for-like and thus an unfair conclusion.
Here, risk professionals should widen the conversation from cost to value: the value of quick payouts, certainty over when payouts will be triggered and greater clarity around financial planning for severe events, the fact that more of a loss is covered, that there are few exclusions and unconstrained use of claim proceeds.
For finance leaders, the better comparison isn't standard cover premium versus parametric premium (or even the premium versus average historic payouts), it’s parametric premium versus the disruption or loss the business can’t absorb without putting performance in peril.
How can you address basis risk when presenting parametric insurance to decision-makers?
Another misconception often faced is the concept of basis risk. This is where a policy’s response does not match the loss suffered. When designing a parametric policy, this can be minimized by ensuring that the payout table aligns with the likely level of loss.
Becoming comfortable with basis risk is important, but in every parametric policy, the aim is to reduce basis risk and provide payouts when it matters most.
We often find providing risk analytics showing how historical events would have triggered a parametric policy and how that policy would have performed is a simple and helpful way to understand how the policy would pay out in the future.
You could, for example, show what different water levels would have meant for a given site and where disruption might begin before property damage starts. If interrogating historical events, the insured should be asked to also list those loss costs that were not covered by an insurer as well as those that were. Thought should be given to why those costs were excluded and whether these were a material impact to financials.
You can also combine scenarios and predictive modeling to help decision-makers better understand the likelihood and magnitude of likely events and show when and how a parametric policy would kick in.
Giving your board a clearer, more appropriate view of the tradeoffs means quantifying the disruption not covered by your current program. Where would access issues, facility closures or excluded causes of loss create real earnings pressure? Analytical assessments give decision-makers credible answers to make informed decisions on the value of parametric solutions.
How can parametric insurance work for your business?
One business we supported was a manufacturing facility located adjacent to a river. During floods, the facility stayed standing and could still technically operate due to its defenses. But employees couldn’t reach the facility for days because surrounding access routes were closed.
Modeling showed a major event could disrupt the wider community for 10 days, leaving production stalled and time-sensitive materials at risk even without major physical damage.
This source of loss was not in the manufacturer’s traditional cover, meaning the business faced a protection gap. However, by placing a parametric policy, the wider non-damage business interruption and damage caused by flooding could be covered.
More widely, parametric insurance can help your organization cover a range of costs: spoiled stock, payroll, continuity, or even relocation expenses, where delays in claims from traditional coverages might otherwise deepen your losses.
Parametric policies can also support outdoor sporting or leisure and hospitality businesses. Venues may need to close because of severe weather or flooding, which render operations unsafe or disrupt critical services, even if there’s no damage to assets. In these situations, businesses may not have sufficient cover in place, leaving themselves financially exposed to these risks.
However, parametric insurance can close these gaps, by paying out based on the measurement of severe wind, heavy rainfall, or rising water levels, or even following a severe weather warning in the area.
How can you position parametric insurance within your broader risk financing strategy?
Position parametric insurance as part of a broader insurance program, acknowledging where traditional insurance is still responding well in some areas, while engineering controls, site defenses and continuity planning reduce exposure in others.
Show parametric coverage as closing gaps around those risks that remain uninsured, underinsured or too slow to fund in crises.
Could parametric insurance close insurance gaps for your business? Get in touch with our alternative risk transfer specialists to find out.
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