What is Parametric Insurance?
The National Association of Insurance Commissioners (NAIC) defines parametric insurance as a type of insurance contract that “insures a policyholder against the occurrence of a specific event by paying a set amount based on the magnitude of the event, as opposed to the magnitude of the losses in a traditional indemnity policy.” (NAIC).
While parametric insurance is typically encountered in the context of disaster insurance policies, there are opportunities to incorporate such policies into more traditional auto and/or home policies that are more familiar to the average consumer. The introduction of these policies may lessen the amount of time and money spent investigating certain claims and could alter the way insurance companies and attorneys—on both sides of the “v”—approach civil litigation.
How Parametric Insurance Works
Parametric insurance policies are essentially if-then propositions with pre-negotiated terms controlling the outcome.
For example, a disaster insurance policy may establish that if a hurricane makes landfall and damages a policyholder’s property, a pre-agreed sum of money will automatically be paid out upon confirmation that a hurricane had, in fact, damaged the property. The policy may increase the payment based on the severity or category of the hurricane. (For example, a Category 2 hurricane might prompt an automatic payment of $25,000, while a Category 3 hurricane might prompt a $50,000 payment).
Both the insurer and the insured know exactly what will happen in the event of a hurricane, and neither would be subjected to a drawn-out, costly investigation to determine the exact dollar value of the damage. The terms of the agreement are pre-bargained, providing certainty for both the insurer and the insured and expediting the outcome. In this way, such policies are essentially liquidated damages clauses or similar in function to a flat-fee arrangement. Just as such clauses provide parties to a contract assurances concerning what constitutes a breach and what the compensation will be if that happens—without prolonged investigation or litigation— parametric insurance policies provide similar benefits to home and auto policyholders and their insurers.
A Hypothetical Application
Take, for example, an insurance claim made after a rear-end collision. The hypothetical claimant, Clark, was stopped at an intersection when he was struck from the rear by an inattentive, uninsured motorist. Clark’s vehicle was only slightly damaged, and he didn’t exhibit any signs of immediate injury. The next day, he developed back pain. He sought treatment at the Emergency Department and received follow-up physical therapy from a clinic of dubious repute. Clark submitted a claim to his insurance company, seeking repayment for both the auto accident and his subsequent medical expenses. Under normal circumstances, Clark’s insurance company would likely seek additional information concerning the nature of the accident and the medical necessity of Clark’s post-occurrence treatment. A lengthy investigation by the insurance company could prompt Clark to file suit, leading to even greater litigation costs and uncertainty for each party.
Alternatively, had Clark’s policy pre-bargained for the potential of a low-speed, no-fault collision, the costly investigation and potential suit could have been avoided. A parametric insurance policy could provide payment of an agreed sum for no-fault collisions under a certain speed (10 mph, for example). That same provision could likewise establish a pre-agreed sum for reasonable medical expenses. After a cursory investigation confirmed the no-fault nature of the accident and the probable speed of the collision, the provision could automatically trigger payment, avoiding time, money, and the angst of prolonged investigation or litigation.
Of course, the parties could still disagree about the relative fault and the circumstances preceding the collision, and Clark might still pursue litigation. However, the scope of issues could be significantly narrowed, essentially removing damages from the equation.
Limitations and Opportunities
While parametric insurance may be inapplicable to the vast majority of third-party insurance—given that a typical plaintiff is unlikely to be a party to the insurance agreement—the application in first-party and uninsured motorist claims may provide an avenue to avoid needless squabbles over relatively minor disputes. This paradigm shift could thus benefit both insurers and insureds: insurers could gain a greater ability to predict payout costs, insureds could receive their proceeds more quickly, and both could significantly reduce—or sometimes even eliminate—protracted and costly litigation.