Parametric insurance is a relatively recent type of insurance policy that has been available since the early 2000s. According to a report by Global Market Insights, the global parametric insurance premium is estimated at USD 16.2 billion in 2024 and is projected to reach USD 51.3 billion in 2034. It is important for general insurance actuaries to understand this product, as its design, pricing, and reserving methods are distinct from those used in traditional insurance. This article outlines how parametric insurance operates, highlights its differences from traditional indemnity insurance, examines current applications of parametric insurance and anticipated growth, and discusses key considerations for general insurance actuaries.
Parametric Insurance vs Traditional Insurance
Parametric insurance differs fundamentally from traditional indemnity insurance. Traditional indemnity insurance policies compensate the policyholder for losses sustained due to a covered event. Determining coverage eligibility and calculating claim amounts can often be complex and time-consuming. In contrast, parametric insurance establishes clearly defined and objective loss triggers. Upon activation of such a trigger, the policy stipulates a predetermined payout, irrespective of any actual loss incurred by the policyholder.
Parametric insurance has typically been used for property catastrophe coverage. The trigger for payment may be wind speeds above a specified threshold or an earthquake exceeding a certain magnitude on the Richter scale. This allows policyholders to receive funds more quickly than conventional insurance, which may require claims adjustment in areas that are difficult to access for extended periods. Compensating policyholders promptly after a catastrophe provides them with funds when they need it the most.
Parametric insurance has also been used for agriculture coverage. Consider farm owner losses caused by drought conditions. Droughts affect both crops and livestock. Crop production decreases significantly under drought conditions. Farm owner expenses increase to mitigate crop losses and to keep livestock healthy. Rainfall levels over a defined period of time can be used as the loss trigger. Additionally, it’s often difficult to precisely determine losses to farm operations experienced from drought conditions. Parametric insurance solves this by setting a fixed payout when the loss trigger condition is met.
The advantages of parametric insurance over traditional insurance are clear.
- Quicker payments to claimants than traditional insurance.
- Simplicity of policy coverage regarding loss trigger and claim payment means that the insured better understand the coverage provided. (Traditional indemnity insurance policies can be quite complex in the description of what losses are covered often leading to misunderstanding of the coverage provided to the insured.)
- Efficiency of resources as the insurer will rarely encounter policy disputes or incur loss adjustment expenses.
- Provides access to catastrophe coverage that may not be available in the traditional insurance market.
However, parametric insurance has some disadvantages.
- Compensation is not linked to actual losses. Because it is not indemnity insurance, the claim payment may be higher or lower than the loss incurred. An insured could have no losses of significance when a trigger is met but still collect the specified payment. Conversely, the payment may be significantly lower than the actual loss.
- Depending on what coverage is to be provided, there may be difficulty in determining an appropriate loss trigger. (The data for the loss trigger must be reliable, and accessible. Additionally, the loss trigger should be highly correlated to losses.)
- Policyholders may not fully understand that they will not be covered for a loss if the loss trigger is not met.
- There may be potential regulatory or legal barriers for using parametric insurance for certain lines of business.
Parametric insurance can only apply when there exists an appropriate loss trigger that has a strong correlation to losses being incurred. For example, it cannot be used for theft of property coverage or malpractice liability coverage for reasons that should be obvious. But it can be very useful for coverage of losses from climate or geological events where appropriate loss triggers exist.
Growing Use of Parametric Insurance
The introduction to this article cited a growth statistic for parametric insurance premiums. This was a projection by a marketing research firm, Global Market Insights, not a firm focused on the insurance industry. Several other marketing firms have made similar projections. For example, Allied Market Research noted a market of USD 18 billion in 2023 projected to grow to USD 34.4 billion in 2033 and Market.US predicts USD 15.8 billion to 40.6 billion over the same time horizon. This compares to total general insurance premiums of over USD 2.5 trillion globally[1] for 2024. So, parametric insurance premiums are approximately 0.6% of the total 2024 general insurance market premiums. I have not checked the veracity of the parametric insurance estimates and projections cited but only report what I could access. There is a lack of accessible insurance data splitting parametric insurance from traditional insurance as insurers do not currently publicly publish this.
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Catastrophe bonds, aka cat bonds, are financial instruments in which catastrophe risk is taken on by investors in capital markets. The cedent for these bonds include commercial insureds, insurance companies and reinsurance companies. Some catastrophe bonds use measurable loss triggers. The model for parametric insurance was based on this. |
While the actual numbers may be up for debate, parametric insurance premiums are expected to significantly increase over the next ten years.
The most notable reason for growth is the issue regarding the availability / affordability of traditional insurance for some types of climate related catastrophes. In the 1990s, catastrophe bonds helped to partially address this issue. Parametric insurance provides another means to address this issue.
Parametric insurance has been used for hurricanes, earthquakes and droughts. There is now an expansion of parametric insurance to cover other types of events. Consider renewable energy produced by wind turbines or solar panels. This is a growth industry. However, the producers of this energy can suffer losses if wind is insufficient over a certain amount of time, or if the number of cloudy days exceeds a certain amount. Parametric insurance could be used for this loss exposure (if it isn’t already).
Parametric insurance is well suited for protecting weather-dependent activities such as events, tourism and certain businesses. Consider the following examples:
- A large outdoor show may see a major decline in day-of-event ticket sales if rainfall is significant.
- Ski resorts rely on a certain amount of snowfall during peak season to be profitable.
- A frozen yogurt shop could experience a drop in sales if temperatures do not maintain certain levels.
There are many possibilities.
Actuarial Opportunities and Issues
Actuaries can be involved in the process of designing and pricing. Consider the fact that one of the challenges with parametric insurance is the definition of the coverage trigger. Actuaries can assist in this as this will affect the price of the product. Actuaries can provide pricing based on different triggers and trigger points. Actuaries can study the strength of the trigger correlation to losses for potential insureds. Actuaries have the skill set to provide this information professionally and increase the likelihood of a product being profitable (at least in the long run).
There is no challenge to setting reserves for parametric claims. If a loss trigger is met, the amount of the claim is set, and loss adjustment expenses are nonexistent (or minimal). Also, loss development shouldn’t occur (or be minimal) because the claim amount is fixed and the loss trigger is usually defined with information available within the policy period. The challenge for actuaries is that this type of insurance will likely not be segregated from traditional insurance in the reserve analysis database. As this business grows, it will begin to distort the observed loss development patterns on a combined traditional-parametric basis. Adjustments will have to be made to consider the growth of parametric insurance as it affects historical loss development patterns. Reserving actuaries will need access to parametric insurance premiums and claims to make the proper adjustments. Not having this information could create misstatements of reserves and reserve opinions.
While parametric insurance is a niche market, it is growing and shouldn’t be ignored. It will not replace traditional insurance, but it can be extremely useful for certain types of coverage. Both pricing and reserving actuaries should be knowledgeable about this type of insurance. Most people will say insurance is not exciting, but for those in the industry, this can be viewed as an interesting development in insurance.
This article is provided for informational and educational purposes only. Neither the Society of Actuaries nor the respective authors’ employers make any endorsement, representation or guarantee with regard to any content, and disclaim any liability in connection with the use or misuse of any information provided herein. This article should not be construed as professional or financial advice. Statements of fact and opinions expressed herein are those of the individual authors and are not necessarily those of the Society of Actuaries or the respective authors’ employers.
Anthony Cappelletti, FSA, FCIA, FCAS, is a staff fellow for the SOA. He can be contacted at acappelletti@soa.org.
[1] Allianz global insurance report (2025-05-27-global-insurance-report.pdf) provides an estimate in Euros (EUR). This was converted to U.S. Dollars (USD) at a conversion rate of 1.15 times the EUR estimate.