When an earthquake hits, insurance claims follow. Traditional insurance payouts are based on the losses the insured party suffered, but for large earthquakes, this can be problematic because determining the actual losses for multiple policyholders can be a slow process. Thus, parametric insurance solutions can be used instead.
Parametric insurance solutions not only provide faster payouts but can also be customized to the needs of the insured.
Some governments prefer the approach to earthquake insurance that parametric insurance provides. In 2007, 16 Caribbean countries formed the Caribbean Catastrophe Risk Insurance Facility (CCRIF), which was the first multinational insurance pool in the world.
In parametric insurance solutions, the parameters (hence the term “parametric”) that determine a payout are set before the disaster ever occurs. This is accomplished by analyzing key measurable and reliable parameters that correlate well with observed losses in past disasters. For example, for earthquake-related insurance claims, the quake’s magnitude, location and depth as reported by reputable third-party institutions, such as the U.S. Geological Survey (USGS), can be reliably used to calculate payouts.
Catastrophe risk models needed for the third-generation triggers are increasingly able to handle the complex demands of parametric insurance solutions. This is particularly important for emerging economies whose insurance markets are not yet well developed. For these insurance markets, parametric insurance solutions offer an effective way of coping with damages from large disasters, decreasing the likelihood that initial earthquake losses will evolve into larger-scale economic or humanitarian crises.
All parametric insurance policies are underwritten in a manner analogous to the traditional insurance policies. From an operational perspective, parametric instruments require a calculation agent, which must be an independent and well-reputed party that monitors and calculates payouts as long as a policy is active.