What is Parametric Insurance & Why Is It Becoming More Popular?

Parametric insurance is a unique type of insurance where insurers payout if certain conditions are met without requiring adjusters to individually evaluate each claim or quantify damages.

As natural disasters become more common and severe, some individuals and communities are looking to parametric insurance.

What is Parametric Insurance?

Parametric insurance, also known as index-based insurance, covers the overall risk of a specific event occurring.

Traditional insurance is known as indemnity insurance. Two parties (you and your insurer) sign a contract, and one party covers the cost of making the other party whole if specific conditions occur.

Parametric insurance works differently:

• Parametric insurance covers risks without sending adjusters to evaluate specific damages after a loss.
• Instead of covering specific damages, parametric insurance issues an agreed-upon payout if certain conditions are met.
• If a certain amount of rain hits a region, for example, or if a certain wind speed is reached, then insurers pay an agreed-upon amount to the policyholder.

The goal of parametric insurance is to reduce the administrative costs of claims handling while speeding up payment, easing the burden on both insurers and policyholders.

Risks Covered by Parametric Insurance

Parametric insurance covers the probability of a severe event occurring instead of the actual damage from the event.

Typically, insurers can use parametric insurance to cover risks in the following situations:

• Requirement #1: The Risk is Fortuitous: When a risk is fortuitous, it means it happens by accident or chance instead of on purpose.
• Requirement #2: The Risk Can Be Modelled: Parametric insurance involves setting specific thresholds, or objective values, to quantify a risk. A hurricane may need to hit a specific wind speed or air pressure metric, for example, to trigger parametric insurance. Insurers rely on measurements from major weather organizations – like the US Geological Survey (USGS) for earthquake magnitude readings and the National Hurricane Center’s Saffir-Simpson category for hurricane severity.

Types of risks covered by parametric insurance could include:

• Earthquakes
• Tropical cyclones
• Floods

Parametric insurers could use earthquake magnitude, windspeed, or rainfall measurements to quantify the above risks.

Why Parametric Insurance is Becoming More Popular

According to Jeff Dunsavage at the Insurance Information Institute, parametric insurance is becoming more popular across the United States – mostly because of the increased risk and severity of natural disasters.

In 2024, the United States experienced $27 billion in damages from natural disasters. Those natural disasters included severe inland flooding and costly storms. Many of these damages weren’t covered by insurance.

When natural disasters occur, it can take months for insurers to process claims. In California, for example, insurers claim it could take up to 18 months to restore damage after the January 2025 fires across Los Angeles.

Parametric insurance could resolve this issue, speeding up the process for insurers and policyholders alike.

As proof, Jeff Dunsavage cites the efficient payment of climate risk-management firm Arbol. The company paid $20 million in parametric insurance claims within 30 days of Hurricane Milton making landfall in Florida in October 2024.

Communities Are Considering Parametric Insurance

Parametric insurance may be a solution for communities facing climate risk.

As Jeff Dunsavage points out, communities across the country have already purchased parametric insurance to protect vulnerable citizens:

• New York City launched a parametric flood program after Superstorm Sandy, helping to protect low-income neighborhoods struggling to cover. New York City expanded that insurance program last year.
• California recently launched a pilot parametric insurance program for specific communities across the state. California selected the flood-prone town of Isleton in Sacramento County for the pilot, as Isleton sits in a flood plain. The community is now protected by a two-year, $200,000 grant.
• FloodFlash, a London-based parametric flood insurance provider, is rolling out coverage across the United States. After initially launching in five states, FloodFlash saw enough demand to expand across the lower 48. The company specifically targets areas unsupported by traditional insurers, offering flood insurance beyond what’s provided by the National Flood Insurance Program.
• States are increasingly passing legislation to cover parametric insurance. Vermont and New York, for example, recently updated laws making it easier to enter into parametric insurance contracts.

Parametric Insurance Could Complement Traditional Insurance

Parametric insurance may not be a replacement for traditional insurance; instead, the two types of insurance could complement one another.

Traditional insurance covers damages to your physical property, for example, and makes you whole again after a loss. It covers the cost of replacing your roof after a hurricane.

Parametric insurance, on the other hand, can cover things not covered by traditional insurance. Parametric insurance could cover costs that are difficult to quantify, for example, or costs that insurers struggle to underwrite.

Downsides of Parametric Insurance

Parametric insurance solves some insurance problems, although it could create others.

Parametric insurance involves setting specific targets – like for rainfall and windspeed. If those targets aren’t met, the insurer doesn’t pay.

This payout system puts some risk on policyholders – especially when events are severe enough to cause damage but not severe enough to trigger a payout.

When Hurricane Beryl struck the Gulf Coast in July 2024, for example, a $150 million parametric insurance bond didn’t payout because air pressure levels missed the predefined minimum.

Final Word: Watch for Parametric Insurance to Continue Rising

As mentioned above, parametric insurance is becoming more common in communities across the United States.

As the risk and severity of natural disasters continues to rise, parametric insurance could help solve problems for insurers and policyholders, speeding up payouts and reducing administrative costs.

Stephanie Corona

Stephanie is a property insurance claim expert with over 20 years of experience working as an insurance adjuster, expert witness, appraiser and umpire. She is passionate about sharing her expertise, knowledge, tips and training to help both property owners and Public Adjusters in their pursuit of effectively managing claims and recovering the claim settlement they deserve after a loss.