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Living With Climate Change: What is parametric disaster insurance? It just delivered a speedy payout in Florida for Hurricane Ian

At least some Florida property owners who suffered the wrath of September’s destructive Hurricane Ian along the Gulf Coast have been able to cash their insurance checks before the holidays.

What’s behind the historically fast payout in a state notorious in recent years for heady lag times for adjusters to visit damaged sites, or for claims to languish in the courts, not to mention a mass exodus of property and casualty insurance carriers: parametric insurance, a type of insurance that covers the probability of a predefined event happening instead of indemnifying, or assigning value to, the actual damage incurred.

It’s not brand new, but parametric insurance is drawing more widespread interest, particularly as climate change is creating ever-stronger natural disasters the likes of Ian, which require more robust tracking data and pack plenty of unpredictability. Climate change, for instance, makes for intense storms that are less likely to be knocked down in strength by a land mass, such as Florida, as has been typical historically.

Arbol, a fintech and climate-change risk company, announced this week that it had delivered a $10 million parametric reinsurance payout to Centauri Specialty Insurance, which issues homeowner policies. Sarasota, Fla.,-based Centauri is licensed in 10 states throughout the Gulf and Southeast U.S. regions, plus Hawaii and Massachusetts.

Arbol argues that its payout, delivered in October, was among the very first for damages related to late-September’s Ian. For sure, the turnaround is markedly faster than is typical. Most claim payouts through traditional insurers can take months, if not years, after damage is incurred.

When Ian, the strongest of a back-loaded 2022 hurricane season that just ended, made landfall as a Category 4 storm in southwest Florida, it left nearly 150 people dead and created a swath of destruction in its wake as it moved northeast across the state. Ian then struck South Carolina as a Category 1 storm.

How parametric policies work

Parametric policies are based on pre-defined events, such as hurricanes of a certain strength, flooding of a certain depth, drought of a certain duration, and heat reaching deadly levels. Damage itself doesn’t trigger an insurance claim, known as an indemnity payout; rather, parametric insurers will issue the funds if a certain threshold is met — for example, if a storm reaches a certain intensity level. 

Of course, if actual property damage occurs, the policy is already in hand, but even without physical damage, the very risk of such damage triggers a payout. This can be especially beneficial if businesses, for instance, lose revenue when storm evacuations create ghost towns.

Related: This ‘incredibly powerful’ home-insurance policy will make payouts even if your property isn’t damaged

Events must be measured by pre-determined expert data sourcing, and check off the already-set parameters for a retail insurance company to collect, such as in the case of reinsurance policies, or for a consumer to receive a payout, in the case of direct policies.

In addition to a reworked insurance formula, it’s the advanced artificial intelligence (AI) and other technologies, including blockchain, that allow for more precise predictions, pricing and delivery of insurance money, and it means that no human is required to visit the site of destruction and assign a damage value, Arbol said in a statement. Arbol, for instance, pays out using National Hurricane Center data provided by the data firm dClimate.

“The data and calculation mechanism is transparent, as it is pre-agreed before the contract commences,” said Sid Jha, the CEO and founder of Arbol.

“Clients have been having trouble getting paid quickly and fairly from the insurance companies. And the insurance companies themselves get stuck in their own sort of claims process because they don’t hold a lot of the risk,” Jha told MarketWatch, describing the benefits of parametric reinsurance in particular.

“If the insurers have a healthier balance sheet and are able to pay, that only helps the consumer also, at the end of the chain,” he said.

Jha said speed and efficiency can also be improved by the way that policyholders are paid, which in the case of Arbol includes blockchain, or a centralized financial ledger that cuts out a banking middleman in processing payments.

Climate change means insurance must change

Because of Ian, even a relatively calm 2022 hurricane season was still an expensive one.

Estimates from the weeks after the storm made landfall indicate insurers could be on the hook for as much as $57 billion to $65 billion in insured damages, and that’s only about half of Ian’s total destruction. However, processing claims and distributing payouts from homeowners, businesses and other entities across the state could take anywhere from a few months to years, as was the case with claims associated with Hurricane Irma in 2017.

Related: Hurricane season’s late start made for an average year but a big insurance bill

For sure, total damage from devastating storms can tally well above the value of insurance coverage. Led by the deadly and costly Hurricane Ida in the U.S. and massive flooding in Europe, the world racked up $329 billion in economic losses linked to severe weather in 2021, and only 38% of that bill was covered by insurance.

“During recent years, back-to-back storm seasons have battle tested insurers in our region and changed the landscape of our insurance industry,” said Ricardo Espino, the CEO of Centauri Insurance. “As insurers, we have to start thinking outside the box and seek innovative solutions for mitigating risk.”

In Florida, for instance, many traditional insurance names have pulled out, in part due to a flurry of court actions in a litigation-friendly state. Action is meant to force insurers to pay more, but is also holding up claims, sometimes for years. In fact, the insurance-carrier exodus has reached a point where some who regularly cover the sector venture to call it a “crisis.”

Instead, specialty insurers known as excess and surplus (E&S) carriers push into these areas. They take on extra risk and often are licensed outside the state where standard insurers have left. For consumers, that may mean the chance to buy insurance when they otherwise could not, although at a higher cost.

A beleagured traditional insurance market in the Sunshine State and elsewhere, including the high-fire-risk zones of California’s vacation destinations around Lake Tahoe, simply opens the door for creative solutions, such as parametric policies, their proponents argue.

“Unlike traditional insurance, parametric weather insurance rates are holding steady,” said Andrew Klaus, vice president of business development at Vortex Insurance Agency, LLC, writing in a commentary posted on LinkedIn last year.

He based his assessment on a couple of factors, but importantly, parametric insurance pricing isn’t affected nearly as much by more severe weather patterns because it pays out when certain thresholds are met. If you have a policy that will pay out after a quarter inch of rain during a certain time period, then it doesn’t matter if it rains a quarter inch or five inches — the policy still pays out at the same rate.

Read: A retirement safe from climate change? Ask the tough questions about real estate and property insurance

There’s still risk of being underinsured

To be sure, insurance of all types is still a game of educated guesses. And the actuarial calculations that go into parametric insurance are no simpler than those of traditional policies.

The most obvious downside to a parametric insurance policy is basis risk, says the National Association of Insurance Commissioners, which helps guide state regulations. That means the economic losses of the insured could differ by any margin from the amount of coverage, or the insured could have losses without the parameter being triggered.

“Accurately structuring and pricing the product requires a firm understanding of the exact exposures of the policyholder and carefully selecting the most appropriate parameter to fit those exposures,” the NAIC said.

Jha said the majority of Arbol’s growth has come from parametric programs in the agriculture and energy sectors, with ongoing expansion into the leisure/travel and climate risk sectors. Arbol recently announced a partnership with SingLife from Aviva to offer the first parametric rainfall coverage for travelers, allowing for payback if a soggy stay ruins a hiking trip, for instance.

Parametric insurance, for now at least, might find its best role as a supplement to traditional insurance, when available.

“Where parametric really fits in, though, is a couple of areas. One, you know, in many cases, like in Florida, a lot of coverage areas are excluded,” Jha told MarketWatch. “And these exclusions are increasing. … [Y]ou can’t even find an insurer, or one either locks you in based on a certain location or a certain type of risk, like a very strong hurricane. Then, even if they do cover it, the deductibles continue to increase.”

“Exclusions and deductions are where parametric can really help to fill out that coverage,” he continued. “When you do go through a devastating event, it gets you paid quickly so you can also start the rebuilding process while your traditional policy is still being negotiated.”

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