What is parametric insurance? He just delivered a quick payout for Hurricane Ian

At least some Florida homeowners who bore the wrath of September’s devastating Hurricane Ian along the Gulf Coast were able to cash their insurance checks before the holidays.

What’s behind the historically quick payout in a state known in recent years for excruciating delays for adjustments to visit damaged sites or for claims languishing in court, let alone a mass exodus of property and casualty insurers: Parametric insurance, a form of insurance that covers the probability of a predefined event occurring rather than compensating or assigning a value to the actual damage suffered.

This is not all new, but there is more widespread interest in parametric insurance, especially as climate change creates increasingly severe natural disasters like Ian, which require more robust tracking data and are highly unpredictable. Climate change, for example, creates intense storms that are less likely to be overrun by a land mass like Florida, as has typically been the case historically.

Arbol, a fintech and climate change risk management company, announced this week that it has made a $10 million parametric reinsurance payout to Centauri Specialty Insurance, which issues home insurance policies. Based in Sarasota, Florida, Centauri is licensed in 10 states in the Gulf and Southeast regions of the United States, as well as Hawaii and Massachusetts.

Arbol claims his payment, made in October, was among the very first for damages related to Ian from late September. Naturally, the turnaround time is significantly faster than usual. Most payouts from traditional insurance companies can take months or even years after the claim has occurred.

When Ian, the strongest of a 2022 hurricane season that just ended, made landfall as a Category 4 storm in southwest Florida, it left nearly 150 people dead and created a swath of destruction in its wake as it moved northeast on across the state. Ian then hit South Carolina as a Category 1 storm.

How parametric policies work

Parametric policies are based on predefined events, such as hurricanes of a certain strength, floods of a certain depth, droughts of a certain duration, and heat that reaches lethal levels. The damage itself does not trigger an insurance claim, known as a compensation payment; rather, parametric insurers will issue the funds if a certain threshold is reached—for example, if a storm reaches a certain level of intensity.

Of course, if actual property damage occurs, the insurance is already in effect, but even without physical damage, the very risk of such damage triggers a payout. This can be especially beneficial if, for example, businesses lose revenue when storm evacuations create ghost towns.

Related: This ‘incredibly powerful’ home insurance policy will make payments even if your property is not damaged

Events must be measured by a predetermined expert data source and tick the already defined parameters that a retail insurer can collect, as in the case of reinsurance policies, or for a consumer to receive payment, in the case of direct policies.

In addition to a reworked insurance formula, it is advanced artificial intelligence (AI) and other technologies, including blockchain, that enable more accurate money predictions, pricing and delivery. insurance, and that means no human being is required to visit the site of destruction and assign a damage value, Arbol said in a statement. Arbol, for example, pays using National Hurricane Center data provided by data firm dClimate.

“The data and calculation mechanism is transparent as it is pre-agreed before the start of the contract,” said Sid Jha, CEO and founder of Arbol.

“Customers struggle to get paid quickly and fairly from insurance companies. And the insurers themselves are stuck in their own kind of claims process because they don’t bear much of the risk,” Jha told CNET, specifically outlining the benefits of parametric reinsurance.

“If insurers have a healthier balance sheet and are able to pay, that only helps the consumer, down the line,” he said.

Jha said speed and efficiency can also be improved by the way policyholders are paid, which in Arbol’s case includes blockchain, or a centralized financial ledger that removes a bank middleman from processing claims.

Climate change means insurance needs to change

Because of Ian, even a relatively calm hurricane season in 2022 was still expensive.

Estimates weeks after the storm made landfall suggest that insurers may be responsible for $57 to $65 billion in insured damage, and that’s only about half of Ian’s total destruction. However, processing claims and distributing payments to homeowners, businesses and other entities across the state can take months to years, as was the case with claims related to Hurricane Irma in 2017.

Related: Late start to hurricane season was an average year, but a big insurance bill

It is certain that the total damages caused by devastating storms can greatly exceed the value of the insurance coverage. Led by the deadly and costly Hurricane Ida in the US and massive flooding in Europe, the world racked up $329 billion in weather-related economic losses in 2021, and only 38% of that bill was covered by insurance.

“Over the past few years, back-to-back storm seasons have strained insurers in our region and changed the landscape of our insurance industry,” said Ricardo Espino, CEO of Centauri Insurance. “As insurance companies, we need to start thinking outside the box and look for innovative solutions to reduce risk.”

In Florida, for example, many traditional insurance names have pulled out, in part because of a flurry of lawsuits in a litigation-prone state. The act aims to force insurers to pay more, but also delays claims, sometimes for years. In fact, the exodus of insurance companies has reached a point where some who regularly cover the sector dare to call it a “crisis”.

Instead, specialty insurers known as Excess and Surplus (E&S) are pushing carriers into these areas. They take on additional risks and are often licensed outside of the state where the standard insurance companies have gone. For consumers, this may mean the opportunity to buy insurance when they otherwise could not, albeit at a higher price.

A beleaguered traditional insurance market in the Sunshine State and elsewhere, including high-fire-risk areas of California vacation destinations around Lake Tahoe, simply opens the door to creative solutions, such as parametric policies, their supporters say.

“Unlike traditional insurance, parametric weather insurance rates are holding up,” Andrew Klaus, vice president of business development at Vortex Insurance Agency, LLC, said in a LinkedIn comment last year.

He based his assessment on a few factors, but most importantly, the pricing of parametric insurance is not affected as much by more severe weather conditions, as it pays out when certain thresholds are met. If you have a policy that will pay after a quarter of an inch of rain in a certain period, it doesn’t matter if it rains a quarter of an inch or five inches – the policy still pays at the same rate.

Lily: A retirement sheltered from climate change? Ask the tough questions about property and title insurance

There is always a risk of being underinsured

Granted, insurance of all types remains a game of educated guesswork. And the actuarial calculations involved in parametric insurance are no simpler than traditional policies.

The most obvious downside to parametric insurance is basis risk, says the National Association of Insurance Commissioners, which helps guide state regulations. This means that the insured’s financial loss can vary by any margin of the cover amount, or that the insured can suffer a loss without the parameter being triggered.

“Accurate product structuring and pricing requires a good understanding of the insured’s exact exposures and careful selection of the most appropriate parameter to fit those exposures,” the NAIC said.

Jha said the majority of Arbol’s growth has come from parametric programs in the agriculture and energy sectors, with continued expansion in the leisure/travel and climate risk sectors. Arbol recently announced a partnership with Aviva’s SingLife to bring the first parametric rainfall coverage to travelers, enabling a return on investment if a wet stay ruins a hike, for example.

Parametric insurance, at least for now, could find its best role as a supplement to traditional insurance when available.

“But where parametric really fits in is a few areas. First of all, you know, in many cases, like in Florida, a lot of coverage areas are excluded,” Jha told GameSpot. “And these exclusions are multiplying. … [Y]You can’t even find an insurance company, or you’re locked in based on a specific location or type of risk, such as a very severe hurricane. So, even if they cover it, the deductible keeps increasing.

“Exclusions and deductibles are where parametric can really help fill that coverage,” he continued. “When you go through a devastating event, you get paid quickly so you can also start the rebuilding process while your traditional policy is still being negotiated.”

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