Plapp Insurance Services

TRIGGER-BASED INSURANCE vs. TRADITIONAL CLAIMS-BASED INSURANCE

Insurance works best when people understand what it is designed to do and, just as importantly, what it is not designed to do. Most insurance people and buyers are familiar with traditional insurance. Parametric insurance is newer, less familiar, and often misunderstood. The two approaches can complement each other, but they operate very differently.

Traditional insurance is based on actual loss. A fire damages a building. A pipe bursts. Equipment is stolen. A lawsuit is filed. The insurer investigates what happened, determines whether the loss is covered, evaluates the amount of damage, and pays based on the policy terms and conditions. Claims handling, documentation, inspections, depreciation, deductibles, exclusions, and valuation methods all come into play.

In other words, traditional insurance is designed to indemnify the insured. The goal is to restore the insured financially, subject to the policy language.

Parametric insurance works differently. Instead of paying based on measured damage, it pays when a predefined event occurs. If the agreed trigger is met, payment is made, whether there is major damage, minor damage, or even no damage at all. The trigger might be:

• Wind speed reaching a certain level • Rainfall or lack of rainfall • An earthquake of a certain magnitude • A temperature measurement • A utility outage lasting a specified period

The payout amount is agreed upon in advance. There is usually no lengthy adjustment process because the claim is not based on proving physical loss. The question is simply whether the trigger occurred.

That difference changes both the strengths and limitations of parametric insurance.

One advantage is speed. Traditional insurance claims, especially large or complex ones, can take weeks or months to fully adjust and settle. Parametric policies may pay much more quickly because there is little or no investigation into actual damage.

Another advantage is flexibility. Traditional insurance policies generally pay only for covered losses defined in the policy. Parametric payouts can often be used however the insured chooses. That might include temporary cash flow needs, payroll, supply chain disruption, cleanup expenses, marketing efforts, or costs that are difficult to insure traditionally.

Parametric insurance may also address gaps where traditional insurance is unavailable, heavily restricted, or financially impractical.

But parametric insurance has important limitations.

It is not designed to match actual loss precisely. A business could suffer major damage yet receive little or no payment because the trigger was not met. Conversely, a business could receive a payment despite suffering minimal damage because the trigger occurred. This is often called basis risk, and it is one of the most important concepts to understand with parametric products.

Parametric insurance is also not a replacement for broad traditional insurance programs. It does not provide the detailed, comprehensive protection offered by commercial property, liability, workers compensation, business auto, or professional liability policies. Instead, it is often best viewed as a supplement or strategic tool.

As risks evolve, insurance is evolving with them. Parametric insurance is one example of the insurance industry experimenting with different ways to address volatility, speed of recovery, and hard to insure exposures. The important thing is not whether one approach is “better” than the other. It is understanding what problem each is designed to solve.