Parametric Insurance

A new way to safeguard your crop revenue

Parametric insurance policies are relatively new to the Australian market. Unlike traditional insurance that aims to indemnify you for your precise loss, parametric insurance policies respond on the triggering of an external index. Once triggered, claims are settled according to a pre-agreed payout scale. As such, parametric policies are sometimes referred to as non-traditional insurance products.

Parametric policies are particularly useful where:

• Traditional insurance is simply not available for a specific peril
• Traditional insurers can only provide limited coverage for a specified peril
• You know you will be impacted by a specific peril but you aren't sure how you will be affected in terms of the type of loss (damage to assets or an interruption to the business) and the financial consequences.

An example might be an orchard exposed to cyclone. Traditional insurance is not readily available to insure the trees. The orchardist knows that a category 3 cyclone within 100km of the orchard will cause damage but is not sure of:

• The nature or extent of the damage, as well as the costs of reinstatement (trees and infrastructure may be damaged or destroyed, access to the property may be impacted, replacement trees, additional labour and equipment may be difficult to secure)
• The immediate, short or longer term financial consequences following the interruption to the business.

An appropriately structured cyclone parametric policy can provide a financial buffer to assist the grower in meeting their immediate and ongoing financial obligations whilst reinstating the orchard and getting back on their feet.

Parametric policies are:

• Simple to apply for — no formal application, detailed historical data, risk information or loss history is required nor are you required to justify your selected sums insured — the sums insured are an agreed value set by you in advance
• Tailored to your requirements in terms of the period of insurance, trigger, sums insured, payout scale, limit and excess
• Transparent and predictable
• Streamlined claims settlement as no loss adjustment is required.

Given claims are based on the triggering of an index, parametric policies also have basis risk — there is the risk that:

• The trigger is met but the policy response does not reflect the financial impact of the loss you have suffered
• The trigger is not met so there is no policy response, notwithstanding the fact that you have suffered a loss.

Basis risk needs to be carefully assessed. If you have had a previous loss from the insured peril the insurer will be able to advise how the policy would have responded to that loss. You can then determine if the structure of cover you have selected would have responded appropriately to the loss that you incurred.