Emergency Funds: Parametric Insurance Provides Predictability
Unlike traditional insurance, which pays on the actual value of a loss, parametric insurance pays for a predefined event.
When the big earthquake hit Haiti in 2010, the country had immediate needs, including food, water and shelter. There was also an urgent need for cops on the beat, yet the country had no cash reserves with which to pay them. Within just a few days an $8 million insurance payment arrived, ensuring there would be a police presence wherever it was needed.
This speedy payment came via a mechanism known as parametric insurance. Haiti had bought into a plan with 16 other Caribbean nations, and when the crisis came, it paid off.
Though parametric insurance has been around for about a decade, it’s still a little known vehicle. That’s changing, though, as government entities come to see its potential value.
Unlike traditional insurance, which pays on the actual value of a loss, parametric insurance pays for a predefined event. “It could be a hurricane, an earthquake, excess rainfall, draught, wildfire, tornado: any quantifiable, measureable natural event,” said Alex Kaplan, vice president of global partnerships at Swiss Re, which wrote the Caribbean policy.
Insurer and insured agree in advance how much will be paid in case of a specific event, and the money goes out as soon as the event occurs. If coverage includes a Category 3 hurricane, for instance, money will be on the move as soon as the winds hit those speeds.
“This is the true benefit of the parametric insurance,” Kaplan said. “Because it is defined based upon the characteristics of an event and not necessarily the actual loss, it can produce a very fast payout, in some instances as little as 10 days, which is critically important for governments. There are still people trying to figure out how much money they are going to get from Hurricane Sandy.”
Speed is a virtue, and so is predictability. Because the value of the policy has been predefined, emergency planners can work their budgets well in advance of an event, and know for sure what will be coming in when the big one hits.
An obvious question arises: What if planners and insurers together have gotten it wrong? What if the policy does not cover the actual extent of the damage? While traditional insurance may be slower, it’s based on the actual loss.
Kaplan’s answer speaks to the sensibilities of emergency planners. It takes careful planning to use a parametric policy appropriately, he said. “They have to have a very good understanding of what their risks are, what their needs are, how quickly they need to receive the payouts.”
Parametric coverage is no silver bullet, Kaplan readily acknowledges. Rather, it can be one part in an overall financial strategy in times of crisis.
“You do need to have other mechanisms in place, including physical adaptation measures to make your city more resilient, as well as other financing mechanisms, for example, by having financing in place, reserve funds or contingency plans that can fill in the gaps,” he said. “The concept we are trying to promote is the idea of comprehensive risk management.”
That logic may prove increasingly appealing as the seeming upward drive in emergency costs continues year after year. “Given the increase in extreme events and the fact the U.S. hits a new record for the number of presidentially declared disasters each year, we may be at a tipping point,” Kaplan said.
With the costs of disasters becoming increasingly unsustainable, “governments and communities at all levels must take a comprehensive and proactive role in protecting themselves both physically and financially from disasters. Emergency managers, as the shepherds of these communities, are well positioned to tackle these issues and ensure we consider all the impacts of disasters and their lasting effects.”
Parametric insurance offers one more tool toward achieving those necessary ends.