Upheavals like climate change, population growth, and rising urbanization levels contribute to catastrophic damages year on year. This calls for effective mitigation strategies that can minimize the financial impact borne by both individuals and businesses alike. Parametric insurance policies aim to safeguard against such situations by offering greater certainty and security through financial protection, based on the probability of an event occurring (before it arises). These policies have been around for a while, but the present demand has been spurred by the COVID-19 pandemic, as uncertainty brought about by the pandemic has forced businesses to re-evaluate their risk management policies.

In this Insight, we take a look at what parametric insurance is about, understand its driving factors, and how parametric insurance start-ups are redefining the insurance industry.

Parametric insurance (also known as index-based insurance) refers to insurance policies that offer predefined payouts based on the “probability” of a predefined event happening (such as an earthquake or a major hurricane), instead of indemnifying the actual loss incurred. 

These policies, therefore, take on a more preventive approach to insurance as opposed to traditional insurance policies (which only pay out claims when an adverse event actually happens) because it quantifies the losses and aims to offer coverage against risks and losses that are typically difficult or even impossible to get insurance for. 

Parametric insurance policies are most commonly taken out to hedge against weather-related catastrophic events, such as natural disasters that include hurricanes and earthquakes, although they can also be applied to other types of risks, such as transport or cyber risks. Parametric policies often include two key components: