Consumers increasingly show interest in parametric insurance products which are developed for low-probability but high-cost risks and are generally preferred for damages that can be caused by natural disasters. After seeing the first sample of parametric insurance in the Caribbean’s, a nest for natural disasters; they continue to become increasingly more popular around the world.
Catastrophic risks are among the most important global risk categories of today’s world. Climate change, global warming, severe earthquakes, floods, and storms around the world have increased the need for protection against catastrophic risks on both personal and corporate levels. Recently, parametric insurance products have become the first solution that come to mind when talking about catastrophic risks.
Parametric insurance is a type of insurance that makes payments to the policyholders in case the parameters listed in the insurance policy have occurred, regardless of the existence of a financial loss or not. In these policies, what matters is the triggering element. Unlike traditional insurance policies, parametric insurance policies consist of a list of parameters. Specific parameters in those lists generally include the types of natural disasters and their values. For instance, let’s say that a parametric insurance policy states that 1 million USD will be paid to the policyholder in case of an earthquake measuring 7.0 or higher on the richter scale. An earthquake of 7 in magnitude occurs in the area where your company is located; but thanks to the precautions you have taken, your financial loss only equals to 50 thousand USD. However, since the parameter listed in your policy has occurred, your insurance company is obliged to pay you 1 million USD, regardless of the amount of your actual loss. Two actions to be taken by your insurance company will be to check whether the magnitude of the earthquake is included among the parameter types or values listed in your policy, and to make you the payment, if the answer is yes. They will not conduct any expertise or damage assessment activities or demand any documents; they will make sure that you receive your claims payments within the timeframe described in your insurance policy.
Parametric insurance products are preferred more and more
The biggest advantage of parametric insurance compared to traditional insurance products can be summarized as being easy and rapid to issue policies and make compensation payments. Unlike traditional insurance policies, parametric insurance policies specify the coverage with narrower and clearer definitions. This means that instead of the classical coverage definition focusing on what is not covered and including other remaining risks within the coverage, parametric insurance policies include a more specific explanation describing what is being covered. The same short and clear definition applies to the conditions for claims payments. Therefore, the two most important steps of the insurance process, technical policy issuing and claims payment, become much easier and faster; while fewer number of employees can offer rapid and uninterrupted services to a wider customer group.
In general, parametric insurance products are mostly preferred for ‘back swan’ risks which have higher magnitude but lower likelihood of occurring. However, policy scopes can be extended to include other risks with lower costs and higher likelihood in case they are defined as parameters.
The most efficient product for risks with high cost but low probability
As mentioned earlier, parametric insurance is used for risks with low probability but high cost. That’s why it is generally preferred as a protection against damages that may occur due to natural disasters.
This practice is known to have been initiated by CCRIF (Caribbean Catastrophe Risk Insurance Facility). Founded in 2007 as a risk pool and with the participation of numerous countries, CCRIF was mainly initiated as a regional fund aiming to compensate for catastrophic damages and continued to operate with this simple structure until 2014. After that, due to the high catastrophe potential in the Caribbean’s, it was transformed into a private asset company and began providing coverage for different geographical regions and risks.
Its foundation was driven by the World Bank and Japan as the country that can find the most interesting solutions for the earthquake risk due to its geographical location. Some other countries in the Americas were included in the program in 2015, after an agreement was signed with COSEFIN (El Consejo de Ministros de Hacienda o Finanzas de Centroamérica, Panamá y la República Dominicana - The Council of Ministers of Finance of Central America, Panama and The Dominican Republic).
Working in close cooperation with the governments of member countries, CCRIF and COSEFIN play a vital role in natural disaster risk zones through the funding they provide. The product offers solutions via cash flows to countries that are experiencing shocking results following earthquakes, tropical cyclones and intense floods.
Growing in Turkey, too
Unfortunately, a regional organization such as CCRIF does not provide services to the region our country is located in. If we consider earthquake as the most significant risk for our country, it is still unclear how Turkey will supply for the cash flow required during the short-term following a potentially destructive earthquake. The first step is to determine how and with which resources to finance the first 24 hours rapidly and without causing any social agitation. It is of vital importance to supply for this need via assessment teams located in a region that will not be impacted by the earthquake and funds supporting those teams. For now, it is evident that it will take a long time according to natural disaster terminology for insurance companies to activate their emergency plans, recover and restart their business processes and respond to customer requirements; especially in case of a potential earthquake in the Marmara Region, where the head offices of insurance companies are located.
Parametric insurance products are getting more and more popular in Turkey as well. However, there are not any statistical assessment as to the share of parametric insurance products among all the current insurance products that are in use. As it makes payments for risks in the policy even though they have not resulted in the expected amount of loss, parametric insurance has the power to attract customers and bring new customers in the system just like a life insurance policy that pays back the capital investment. Insurance companies are currently offering protection for policyholders against climate change and catastrophic risks via parametric insurance products.