Parametric Solutions Target the Trust Gap in Insurance
Tim McCosh, Co-Founder and CEO of Yokahu, looks ahead to what promises to be a busy next year as parametric products step in to bridge the trust gap in insurance
The ongoing global pandemic has once again shown the huge potential value to everyday people in having access to financial support quickly after events that cause catastrophic economic shocks.
The swift action of governments in introducing various support schemes such as furlough and bounce back loans has seen jobs saved and businesses stand a fighting chance of survival. It also saw consumer spending continue and ultimately limit the damage to economies in spite of the huge shock that had occurred.
Contrast this with the insurance sector that has not always covered itself in glory in the handling of claims related to the pandemic - particularly business interruption claims.
And while I’m not here to argue the merits for and against these decisions, it is obvious that the negative headlines they engendered have further damaged trust in a sector already viewed with some suspicion by everyday people.
A longstanding issue
This trust issue is of course not limited to the response to the pandemic - it’s a long-term challenge for insurance as a concept. Take, for instance, the increasing frequency and severity of global natural disasters. According to the Swiss Re Institute, extreme weather events in 2021 resulted in insured losses from natural catastrophes estimated at USD105 billion, the fourth highest since 1970.
However, the overall economic loss from the same events in 2021 was estimated at USD250 billion - revealing a significant global protection gap that has grown year-on-year.
With climate change increasing the intensity and likelihood of natural catastrophes - in particular hurricane, cyclone, tropical storm and flooding events - there has never been a greater need for effective access to disaster risk funding for the people whose homes and livelihoods are at risk.
But clearly, natural catastrophes have led to huge claims on insurance policies, which have in turn fuelled ongoing sharp increases in insurance rates, combined with tightened policy wordings and increasing exclusions. The upshot is the widening protection gap and people’s trust in the industry becoming further eroded.
Communication and transparency
There is a clear need to communicate more effectively and transparently with the insurance buying public. In order to close the protection gap and foster greater resilience in the face of severe economic shocks, our industry must be completely open, honest and do everything it can to ensure its customers and community understand all aspects of a provider’s products and operations and what it is able to provide.
What customers want above anything else are easy-to-buy products that do what they say on the tin (without exception). Parametric at its heart is that simple: If X happens, pay Y.
When done well, parametric insurance solutions bring much needed transparency and security to the table. Often using leading edge technology to provide independent verification of parametric event triggers, many parametric policies offer automatic payouts if triggered.
How does this help bridge the protection gap and improve trust?
Parametric at its heart is that simple: If X happens, pay Y
Parametric insurance can be used to cover risks from a given event that aren’t covered by more traditional insurance policies, thus enabling them to be used to cover circumstances that contribute to any protection gap.
The clarity of the policy trigger is an opportunity to build trust between policyholders and underwriters - there is no grey area, no ‘see the small print’ - the event either triggered the policy, or it didn’t.
The cementing of that trust for the customer will only come when the policy is triggered and the money arrives as promised. Parametric insurance has the potential to bring the insurance sector back to being seen as a trusted partner, an enabler, rather than an unwanted cost.
However, the rate of development of new parametric products has still been too slow to meet the broad spectrum of risks that could be covered. Often too much time is spent on developing or fine tuning ultra-complicated models and triggers that mean the client has moved on or can no longer understand the product, therefore does not trust it and so hit ratios between quote and bind remain low.
There perhaps needs to be a clearer focus on customer centric design and clarity. The old adage of “keep it simple stupid” should be applied where possible.
A change of mindset
This is a shift in the way many people in and around the industry consider and interact with insurance and is taking time to filter through. The opportunity for parametric insurance is vast, but for the industry to grasp it, they still need to be developed faster and in line with customer expectations.
A parametric approach can provide increased certainty to underwriters as well as policyholders, thus presenting a viable way to underwrite new risk types. Digitisation of the contracts enables the products to be administered at a higher speed and lower cost and thus benefit the customer.
All this is laying the foundations for the parametric sector to carve out a far more meaningful presence in the future. New data sources will also help, however it will be a while yet before we will see that effect - it's all very well connecting up new IoT sensors for instance as triggers for a policy, but if there is no historic data on which to base a model and correlate it with the sensor then pricing the risk becomes more challenging.
Providing access to new, affordable products
Two of the areas that have seen the most application of parametric insurance are weather/climate risks due to the availability of data and microinsurance due to the need for simplicity. Some of the most vulnerable to climate risks currently have the least access to insurance products.
However pioneering parametric microinsurance developers are determined to be the first answer in protecting vulnerable communities from natural disasters, by not only providing access to new, affordable products, but also dedicated rapid, immediate support.
The key as with all insurance is distribution, and it's fair to say the opportunities for the distribution of parametric insurance are numerous with many still being explored. Parametric insurance is a great tool to tackle the protection gap, but new distribution channels are just as important if we are to be successful. The lessons learned in these areas can also provide valuable points of reference for products in more traditional insurance markets.
We are seeing an increasing demand for parametric solutions and expect this trend to continue as insurance buyers as well as underwriters continue to appreciate the concept, clarity and confidence on offer in parametric solutions and their ability to unlock new opportunities for both parties.