In Part 1 of this series, we explored the basics of parametric insurance — what it is, how it works and some the of risks it may help mitigate. In this article we will take a deeper dive into the key differences between parametric insurance and traditional indemnity insurance — and how they can work together.
It is important to understand that parametric insurance is not intended to replace traditional coverage. Instead, it can complement traditional insurance coverage by providing an extra layer of protection and/or providing coverage for risks not covered under a traditional policy.
The chart below compares key policy attributes and how they differ.
| Traditional Indemnity Insurance | Parametric Insurance | |
|---|---|---|
| Policy Structure | • Typically a standard product covering a range of common perils. • Long-form policy language with limited customization opportunities. | • Highly customized to cover a specific, verifiable trigger event. • Generally shorter contract length with straightforward language. |
| Coverage Inclusions and Exclusions | • Most policies exclude or sublimit coverage for certain perils, such as floods, earthquakes and cyber liabilities. | • Coverage is strictly limited to the specific, verifiable trigger event and parameters stated in the policy. |
| Policy Term | • Usually one year, with some multi-year options available. | • Typically one year, but terms of 2, 3 or more years are possible. |
| Triggering Event Location | • Covered peril must cause damage to the insured’s property or assets for any coverage, including business interruption, to apply. | • Must occur in a defined geographic area, which can be outside of the insured’s property and direct control, but is key to business operations. |
| Deductibles | • Typically has standard deductibles regardless of the loss amount/severity. | • No deductibles. Payment amounts are based on a pre-determined index. |
| Triggering Event Severity | • No specific event severity is required to trigger coverage under the policy, but there must be damage to the insured’s property or assets. | • The severity of the event must meet the mutually agreed upon parameter in the policy, such as a hurricane with a certain wind speed. |
| Claims Assessment and Payout Process | • Actual losses are determined by an adjuster. • Settlement negotiations may be required. • Based on the complexity, settlement may take months or years. | • Fast payouts with no adjuster or negotiations required. • Payouts are transparent and based on the “occurrence” of the defined trigger event vs. an adjuster’s loss assessment. |
| Claims Proceeds | • Claims proceeds must be used to repair or replace damaged property or assets. | • Proceeds may be used in any manner related to the damage or interruption to the business. |
Let’s look at a hypothetical example of how parametric insurance can provide an extra layer of protection.
A.B. Smith Construction Company: A construction company with a major project underway in Orlando, Florida, just over 84 miles northeast of Tampa Bay, Florida.
Traditional Coverage: Policy provides property damage and business interruption coverage for losses impacting the construction site and all on-site materials, equipment and assets.
Parametric Coverage: Because most of the materials and equipment required for the project arrive via the Port of Tampa Bay and are transported to the project site by trucking companies near the port, the company purchases a parametric insurance policy with the following parameters.
A Category 4 hurricane hits the west coast of Florida. By the time the storm moves inland to the Orlando area it has weakened considerably, but A.B. Smith Construction does suffer the loss of a crane and on-site construction materials. The company reports the claim to their carrier to get the loss adjustment process started. They are glad they have the coverage but know the claim adjustment and settlement process will take time.
While damage to the Orlando construction site was mild, the Tampa Bay area took the full force of the Category 4 hurricane. The Port of Tampa Bay and most of the trucking companies that serve it are shut down indefinitely due to severe storm damage. As a result, A.B. Smith Construction’s Orlando project site cannot get the materials and equipment it needs to resume operations.
This is where the parametric coverage comes into play. Because the storm struck within the specified location and exceeded the wind speeds stated in the parametric policy, A.B. Smith Construction will promptly receive a claims payout of $4.5 million (90% of the total coverage amount as specified in the policy index). The immediate payout will provide A.B. Smith Construction with the cash flow it needs to re-route incoming supplies and equipment through the Port of Miami and quickly get the project back on track.
This is just one example of how parametric insurance can enhance protection and provide quick access to resources when they are needed most. There are a myriad of other ways, such as providing coverage for perils excluded under traditional policies, providing additional capacity or filling in gaps left by high deductibles.
To determine if parametric insurance would be a good complement to your current coverage, you’ll need to talk to a broker with specific expertise in this coverage genre. Conner Strong & Buckelew has the in-house expertise to evaluate your coverage needs and provide the necessary guidance if parametric insurance makes sense for your organization.
For more information on how our team can help, please reach out to your Conner Strong & Buckelew representative, call us at 1-877-861-3220 or email [email protected].
Tim Svoboda, CPCU, ACI, ARe
Vice President, Captive Consultant
