Tag Archives: parametric insurance

Growing Case for Parametric Coverage

Sadly, the insurance-focused news outlets are starting to overflow with references to who is suing whom over certain types of coverage related to the COVID-19 pandemic. There is a growing regulatory and legislative outcry for the insurance industry to pay out in instances where there is no specified coverage or where coverage is actually excluded. Both business and personal lines customers do not fully understand where they are (and are not) covered. It is a pretty dismal picture, and it is going to take a long time to sort all this out. In the meantime, a growing trend provides a glimmer of hope in all this chaos – parametric insurance.

Parametric insurance covers a specific event that can trigger a claim payment based on metrics from a recognized source such as the Richter scale for earthquakes or the number of hours a plane is delayed. While parametric insurance isn’t new – it has been available in emerging nations over the years – usage has been limited and sporadic. During 2019, there were undoubtedly some launches of more mainstream products such as Swiss Re’s Quake Assist product and Sompo’s flood product. However, this month, there have been at least four notable launches or expansions:

  • AXA Climate – AXA partnered with Dutch satellite technology firm VanderSat to derive triggers linked to soil moisture levels, enabling drought-related parametric insurance. The same soil reading technology can determine excess moisture, as well, triggering payment in either direction.
  • Global Parametrics/Arbol – Global Parametrics, a parametric and index-based disaster risk transfer company, teamed up with Arbol, a technology-driven marketplace that uses blockchain and smart contracts to provide weather risk insurance coverage to smallholder coffee farmers in Costa Rica.
  • Parsyl – Parsyl Insurance launched a suite of connected cargo insurance solutions for perishable goods, called ColdCover. Parsyl’s quality-monitoring and risk management platform leverages smart sensors and data analytics to manage the supply chain as well as loss control. The featured product within the company’s new suite is called ColdCover Parametric, which includes customized quality triggers and payout levels.
  • Understory – Understory initially launched its Hail Safe product for auto dealerships this past November but rolled it out to a significant number of additional states in April. The product coverage is triggered through the use of Understory’s proprietary hail sensor. Understory partnered with international weather risk manager MSI GuaranteedWeather to bring the product to market.

These examples are stated simply for brevity. But the scenarios are not that simple. For example, the Global Parametrics and Arbol example also includes an ecosystem of related parties in the transaction. And Parsyl provides services and an extensive risk management system so that cargo and fleet owners can manage exposures. From an education perspective, it is worth getting further details on all four scenarios. However, for purposes of this blog, the particularly hopeful note is that all this has happened in one month – the cycle of innovation and response is speeding up.

See also: Keeping Businesses Going in a Crisis  

Insurers and technology providers are coming together to find opportunities to create products that have specificity in terms of coverage and payment amounts. This is a very good thing! Insurers need to continue to seek opportunities to innovate in this area. Clearly, not all product lines are appropriate for parametric policies. However, in more instances than not, bringing sensors, aerial imagery, weather data and science to insurance products across all product segments can only help create transparency both in coverage creation and in loss settlement. This needs to be a goal for all insurers.

Parametric Solution for Wildfire Risk

Last year saw some of the deadliest and costliest wildfires in California history. With the long-term impacts of the Camp and Woolsley fires still being felt months later, many in California are already thinking ahead and considering how best to prepare for future wildfire seasons. The problem is only going to get worse due to climate change: The total area exposed to wildfires is increasing, and the wildfire season continues to grow longer. Recognizing this new reality, the California Senate recently passed a bill that would authorize the state to purchase insurance to mitigate the costs associated with natural disasters such as wildfires.

When fires threaten a community, all evacuees (even those lucky enough to have homes they can eventually return to) will incur financial impact – from lost wages to the cost of emergency accommodations. These expenses are not generally covered by insurance, leaving a serious protection gap at a vulnerable time. Parametric insurance products could provide immediate financial relief in the form of automatic pay-outs for insureds living in the evacuation zone – these products present an intriguing protection option for California residents and communities.

Automatically Triggered by Pre-Defined Events

Parametric insurance, also known as index insurance, is an innovative product that pays a fixed sum when a precisely defined event takes place – for example, wind of more than a certain speed at a specified location. The insurance is not a direct substitute for conventional insurance because of the “basis risk” – the potential gap between the policyholder’s loss and the payout. But the upsides are certainty and a rapid payout, because there is no claim to be made or adjusted. Those upsides could be appealing in certain circumstances.

Parametric insurance is increasingly being used in the developing world to fund rapid relief and recovery in response to natural disasters, such as drought leading to crop failure. There are moves to develop products that will make a partial payout in advance (for example, if a major storm is forecast) to fund even earlier intervention. As the impact of climate is felt more widely, we may see an increased take-up of parametric insurance in the developed world, too. California wildfires could be a particular case.

Evacuation Costs Impose a Financial Burden

Emergency relief shelters generally provide aid within the first few days of fires, but displaced evacuees soon have to look to other housing options. Reports on the aftermath of disasters show that nearby hotel and motel rates jump. Aside from housing costs, evacuees are often forced to pay out-of-pocket expenses for food, gas and emergency supplies.

Evacuees with homeowner or renter insurance coverage may have traditional insurance policies that eventually help with these costs. Policies with inclusions for “Additional Living Expenses” (“ALE”) typically cover food and housing costs, furniture rental, relocation and storage and extra transportation expenses. However, under the traditional insurance model, insurers will reimburse residents for ALE only after a claim has been filed and adjusted.

See also: How to Fight Growing Risk of Wildfire  

Regardless of whether an evacuee is eligible to receive ALE, the scale of destruction leaves many evacuees uncertain as to how they will afford cost-of-living expenses in the immediate-run. Evacuees unable to afford these costs are subsequently left at the mercy – and often slow response – of government-funded emergency relief.

Parametric Insurance Can Provide Financial Emergency Relief

Parametric insurance can fill the protection gap, providing wildfire evacuees with rapid funding when they are forced to evacuate. Recently approved California legislation will require local emergency notification systems to warn residents of impending danger, and these warnings could serve as a trigger.

A parametric insurance product offered to local municipalities may likewise afford cities and counties with quick and predictable funds. Government emergency relief funds are initially paid to cover state emergency operations. Local municipalities affected by wildfires rely heavily on relief from non-profit organizations, but, when such relief cannot adequately address immediate and longer-term financial needs, the burden is placed back on the residents to pay expenses out of their own pockets.

Parametric insurance policies can be crafted to uniquely address the needs of regions threatened by climate catastrophes. For example, some of those exposed might have traditional insurance policies with significant excesses. Parametric insurance could be used in conjunction with these, so the policyholder receives a speedy payout when cash flow is tight during an evacuation, and then make a conventional claim for the balance of the loss.

Whether used independently or in conjunction with other insurance, a parametric insurance product will lessen many of the financial burdens associated with wildfire evacuations.

A Greater Role for Parametric Insurance

Potential wildfire evacuees are one group that may benefit greatly from a parametric insurance product, but they aren’t the only Californians who could benefit from the predictability and efficiency these products can afford. Parametric insurance is currently used to insure crops from failure due to various weather conditions. This product can similarly be modeled to wineries and commercial agriculturists in Northern California who are concerned that wind, ash and debris from wildfires could diminish quality. With climate change increasing the devastation of wildfires in California, parametric insurance can play an important role in responding to the increasing financial burdens placed on the affected residents.

See also: The Challenges Ahead in 2019  

Beyond California

The number of natural disasters that have wreaked havoc in California recently make the state a natural outlet for parametric insurance products, but it is far from the only area of the country where these products may be useful. Hurricanes routinely leave long-term damage throughout the U.S., from Texas to Puerto Rico to New York; in fact, the number of weather-related loss events in this country has tripled since the 1980s. The ability to provide rapid funding for relief, recovery and reconstruction efforts is an essential need, and parametric insurance provides an effective solution.

There is no simple or one-size-fits-all solution to natural disaster protection. But novel forms of risk transfer such as parametric insurance hold a great deal of potential. This resilience-linked product is an excellent example of how the insurance industry can respond to weather-related threats in effective ways, and represents a key opportunity for future innovation.

Blockchain’s Future in Insurance

Blockchain is a revolutionary technology that is likely to have a far-reaching impact on business – on a par with the transformative effect of the internet. Not surprisingly, the huge potential promised by blockchain has prompted a flurry of research activity across different sectors as diverse organizations race to develop applications.

In this article, we’ll explore the many benefits that blockchain could bring to the insurance industry and the different challenges that will need to be overcome.

Overview

Blockchain has strong potential in the short and long term in several different areas, particularly where it links with emerging technologies such as the Internet of Things (IoT) and artificial intelligence (AI). But its potential for delivering new applications also depends on the development of blockchain technology itself. In the medium and short term, there are three categories where blockchain can be applied:

  • Data storage and exchange: Numerous data and files can be stored using blockchain. The technology provides for more secure, traceable records compared with current storage means.
  • Peer-to-peer electronic payment: Bitcoin (and other blockchain-based cash systems) is a cryptographic proof-based electronic payment system (instead of a trust-based one). This feature is highly efficient while ensuring transparent and traceable electronic transfer.
  • Smart contracts: Smart contracts are digital protocols whereby various parameters are set up in advance. When pre-set parameters are satisfied, smart contracts can execute various tasks without human intervention, greatly increasing efficiency.

Data storage and peer-to-peer electronic transfer are feasible blockchain applications for the short term. At this stage, the technical advantages of blockchain are mainly reflected in data exchange efficiencies, as well as larger-scale data acquisition.

See also: The Opportunities in Blockchain  

Smart contracts via blockchain will play a more important role in the medium to long term. By that time, blockchain-based technology will have a far-reaching impact on the business model of insurance companies, industrial management models and institutional regulation. Of course, there will be challenges to overcome, and further technological innovation will be needed as blockchain’s own deficiencies or risks emerge during its evolution. But just like internet technology decades ago, blockchain promises to be a transformative technology.

Scenarios for blockchain applications in insurance

Macro level

Proponents of blockchain technology believe it has the power to break the data acquisition barrier and revolutionize data sharing and data exchange in the industry. Small and medium-sized carriers could use blockchain-based technology to obtain higher-quality and more comprehensive data, giving them access to new opportunities and growth through more accurate pricing and product design in specific niche markets.

At the same time, blockchain-based insurance and reinsurance exchange platforms – that could include many parties – would also upgrade industry processes. For example, Zhong An Technology is currently working closely with reinsurers in Shanghai to try to establish a blockchain reinsurance exchange platform.

Scenario 1 – Mutual insurance

Blockchain is a peer-to-peer mechanism, via the DAO (decentralized autonomic organization) as a virtual decision-making center, and premiums paid by each and every insured are stored in the DAO. Each and every insured participant has the right to vote and therefore decide on final claim settlement when a claim is triggered. Blockchain makes the process transparent and highly efficient with secure premium collection, management and claim payment thanks to its decentralization.

In China, Trust Mutual Life has built a platform based on blockchain and biological identification technology. In August 2017, Trust Mutual Life launched a blockchain-based mutual life insurance product called a “Courtesy Help Account,” where every member can follow the fund. Plus, the platform reduces operational costs more than a traditional life insurance company of a similar size.

Scenario 2 – Microinsurance (short-term insurance products for certain specific scenarios)

An example of short-term insurance could be for car sharing or providers of booking and renting accommodation via the internet. Such products are mainly pre-purchased by the service provider and then purchased by end users. However, blockchain makes it possible for end users to purchase insurance coverage at any time based on their actual usage, inception and expiring time/date. In this way, records would be much more accurate and therefore avoid potential disputes.

Scenario 3 – Automatic financial settlement

The technical characteristics of blockchain have inherent advantages in financial settlement. Combined with smart contracts, blockchain can be applied efficiently and securely throughout the entire process of insurance underwriting, premium collection, indemnity payment and even reinsurance.

Micro level

Blockchain has the potential to change the pattern of product design, pricing and claim services.

Parametric insurance (e.g. for agricultural insurance, delay-in-flight insurance, etc.):

Parametric insurance requires real-time data interface and exchange among different parties. Although it is an efficient form of risk transfer, it still has room for further cost improvement. Taking parametric agricultural insurance and flight delay insurance as examples, a lot of human intervention is still required for claim settlement and payment.

With blockchain, the efficiency of data exchange can be significantly improved. Smart contracts can also further reduce human intervention in terms of claim settlement, indemnity payment, etc., which will significantly reduce the insurance companies’ operating costs. In addition, operating efficiency is increased, boosting customer satisfaction.

Some Chinese insurers are already working on blockchain-based agricultural insurance. In March 2018, for example, PICC launched a blockchain-based livestock insurance platform. Currently, the project is limited to cows. Each cow is identified and registered in the blockchain-based platform during its whole life cycle. All necessary information is uploaded and stored in real time in the platform. Claims are triggered and settled automatically via blockchain. The platform also serves as an efficient and reliable food safety tracing system.

Auto insurance, homeowners insurance: 

Blockchain has wider application scenarios in the field of auto insurance and homeowners insurance when combined with the IoT. There are applications from a single vehicle perspective as well as portfolios as a whole. From a standalone vehicle perspective, the complete history of each vehicle is stored in blocks. This feature allows insurers to have access to accurate information on each and every vehicle, plus maintenance, accidents, vehicle parts conditions, history and the owner’s driving habits. Such data facilitates more accurate pricing based on dedicated information for each and every single vehicle.

From the insured’s point of view, the combination of blockchain and IoT effectively simplifies the claims service process and claim settlement efficiency.

From the perspective of the overall vehicle, blockchain and IoT can drastically lower big data acquisition barriers, especially for small  and medium-sized carriers. This will have a positive impact on pricing accuracy and new product development in auto insurance.

Taking usage-based insurance (UBI) for autos as an example, it’s technically possible to record and share the exact time and route of an insured vehicle, meaning that UBI policies could be priced much more accurately. Of course, insurers will have to consider how to respond in situations where built-in sensors in the insured vehicle break or a connection fails. Furthermore, insurance companies also have to decide whether an umbrella policy is needed on top of the UBI policy, to control their exposure when such situations occur.

Cargo insurance:

Real-time information sharing of goods, cargo ships, vehicles, etc. is made possible with blockchain and the IoT. This will not only improve claims service efficiency but also help to reduce moral hazards.

In this regard, Maersk, EY Guardtime and XL Catlin recently launched a blockchain-based marine insurance platform cooperation project. Its aim is to facilitate data and information exchange, reduce operating costs among all stakeholders and improve the credibility and transparency of shared information.

International program placement and premium/claims management:

Blockchain-based technology allows insurance companies, brokers and corporate risk managers to improve the efficiency of international program settlement and daily management, at the same time reducing data errors from different countries and regions and avoiding currency exchange losses.

Coping with claim frauds:

Blockchain is already being applied to verify the validity of claims and the amount of adjustment. In Canada, the Quebec auto insurance regulator (Québec Auto Insurance) has implemented a blockchain-based information exchange platform. Driver information, vehicle registration information, the vehicle’s technical inspection result, auto insurance and claims information, etc. are all shared through the platform. The platform not only reduces insurance companies’ operating costs but also effectively helps to reduce fraud.

All insurance companies that have access to the platform receive a real-time notice when a vehicle is reported to be stolen. Insurance companies have full access to every vehicle’s technical information, which promotes more accurate pricing for individual policyholders.

Claims settlement:

Using a smart contract, the insured will automatically receive indemnity when conditions in the policy are met: Human intervention will not be needed to adjust the settlement. In the future, some insurance products will effectively be smart contracts whereby coverages, terms and conditions are actually the parameters of the smart contract. When the parameters are met, policies are triggered automatically by the smart contract and a record stored in the blockchain.

Business models like this will not only build higher trust in the insurance company but will also greatly increase its operational efficiency, reducing costs; it will also help to reduce moral hazard.

Internal management systems:

Internal management systems could be automated through use of blockchain and smart contracts, helping to improve management efficiency and reduce labor costs as well as the efficiency of compliance audit.

See also: How Insurance and Blockchain Fit  

Challenges and problems

Decentralization strengthens information sharing and reduces the monopoly advantages that information asymmetry provides. Under such circumstances, insurance companies have to pay more attention to pricing, product development, claims services and even reputation risk. All this adds up to new challenges for the company management.

At the same time, every aspect of the insurance industry must be more focused on ensuring the accuracy of original information at the initial stage of its business. Knowing how to respond to false declarations from insureds will be crucial.

From a more macro perspective, “localized blocks” of data will be inevitable in the early phase of development in line with the pace of technical development and regulatory constraints.

In theory, it is impossible to hack blockchain, but data protection will be an issue for localized blocks. Therefore, higher cyber security protection will be required to protect these localized blocks.

The interaction of blockchain with other technologies could mean that existing intermediary roles are replaced by new technologies in different sectors. If the insurance industry wants to ensure the continuous development of the intermediary, it should address the possible disruptive risks to existing distribution business models posed by blockchain.

The necessary investment (both tangible and intangible costs) associated with adopting blockchain technology is a big consideration for many companies at this stage. Insurance companies and reinsurance companies operate numerous systems, and the decision to integrate blockchain-based technology/platform shouldn’t be taken lightly. At the current stage of blockchain evolution, this could be one of the biggest obstacles facing insurers.

Overall, blockchain is an inspiring prospect, and there is every reason to believe that this technological breakthrough will bring positive effects to individual insurers everywhere. But at the same time, we need to understand the mutual challenges that lie ahead and work together to promote our industry’s development in what promises to be an exciting new era.

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