Parametric Insurance Example

In the event of flooding, sensors measure the water level on site and payment of the sum insured is triggered the moment the water reaches the predetermined depth.

In the event of an earthquake, parametric insurance policies are designed to provide a payout when certain predefined seismic parameters are met or exceeded. These parameters typically include the earthquake's magnitude, location, and depth, which are measured by reputable third-party institutions such as the United States Geological Survey (USGS). The policy pays out a predetermined sum insured once the earthquake's magnitude reaches or surpasses a specified threshold, as agreed upon in the insurance contract. 

For example, a parametric earthquake insurance policy might stipulate that a payment of $100,000 will be made if an earthquake with a magnitude of 5.0 or greater occurs within a defined geographical area. The magnitude of the earthquake is the parameter, and the USGS could be the third party responsible for verifying that the earthquake has met the required magnitude. The policy would clearly define the amount of payment, the parameter (earthquake magnitude), and the third party verifier in the contract.

Parametric insurance policies for earthquakes are particularly useful because they allow for rapid deployment of funds to the policyholder, which can be crucial for immediate recovery efforts. Unlike traditional indemnity-based insurance claims, which can take weeks or even months to process, parametric insurance payouts are typically issued much more quickly, often within days of the earthquake[2][6]. This speed of payment is possible because the trigger for the payout is based on objective, measurable data rather than on the assessment of actual damages incurred.

To summarize, a parametric earthquake insurance policy would work as follows:

  • The policyholder purchases a parametric insurance policy with a pre-agreed payout amount.
  • The policy specifies the triggering event, such as an earthquake of at least magnitude 5.0.
  • A third-party agency, like the USGS, provides independent verification of the earthquake's parameters.
  • If an earthquake occurs and meets or exceeds the specified magnitude, the policy triggers an automatic payout to the policyholder.
  • The payout is made based on the intensity of the earthquake as experienced at the policyholder's location, without the need for a detailed assessment of damages.

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