Parametric insurance

Unlike traditional types of insurance, which reimburse the policyholder based on the cost of verified losses, parametric insurance covers the probability of a flood or other natural catastrophe happening, rather than any actual losses caused by it.

Parametric insurance, sometimes referred to as index-based insurance, relies on predefined triggers. These triggers are objective, measurable events, such as wind speeds exceeding 100 mph, or an earthquake measuring 6.5 or higher on the Richter scale.

The insurance industry has a couple of underlying requirements for this type of coverage:

• The incident must be fortuitous (in insurance, this means it happens by accident or chance).
• There must be a way to model the relevant factors, such as wind speed or earthquake magnitude, so the insurer can determine the probability of the event.

Once the natural catastrophe (NatCat) trigger is met, the policy pays out a pre-agreed amount, regardless of the actual financial loss incurred.

Parametric insurance is similar to commercial property insurance (also called business hazard insurance), but differs in what triggers a claim. Typically, property damage or financial losses result in an insurance claim, with the amount dependent on the size of the loss.

In contrast, parametric coverage often works as follows:

• Your small business buys a policy to protect against a named peril, such as a wildfire, earthquake, flood, or pandemic.
• The insurance company predicts the likelihood of the event happening in your geographical region, which determines your premium.
• You and your insurer agree upon the parametric triggers for a claim, such as a certain amount of rainfall over a period of time.
• Independent third-party data determines when the triggering event has occurred, such as hurricane data from the National Oceanic and Atmospheric Administration (NOAA).
• Your business receives the payout specified in the policy.

This type of coverage can often complement traditional commercial property insurance or business interruption insurance, also called business income coverage.

Parametric insurance can be tailored to a variety of risks and industries. Some common parametric trigger examples include:

• Parametric earthquake insurance: Pays out when seismic activity exceeds a set magnitude, helping businesses like property managers recover quickly.
• Parametric windstorm insurance: Activated by hurricane-force winds or other high-speed wind events, which is useful for coastal businesses.
• Parametric flood insurance: Triggers when a specific amount of rainfall or water level is recorded—especially valuable for businesses in flood-prone zones.
• Climate risk parametric insurance: Covers events like drought, wildfire, or heatwaves. Helpful for sectors like agriculture or cultivation.

A parametric insurance policy is a practical solution for businesses in sectors where extreme weather and natural events can disrupt operations.

Some of these industries can include:

• Agriculture and cultivation: Farmers and growers rely on weather for yields, making drought and flood coverage critical.
• Tourism and special events: Event planners, photographers, and nonprofits can suffer economic loss from weather events that impact their daily workload or a special event.
• Coastal businesses: From retailers to seafood processors, tropical cyclone and hurricane risk can devastate operations in coastal states, such as California, Florida, and Texas.
• Construction and real estate: Weather delays or natural disasters can stall projects or damage sites (such as real estate or construction contractors).

Parametric insurance claims are independent from property losses, so the value of your business property isn't a factor like it is with commercial property coverage.

Instead, your insurer will look at the following factors to determine the pricing of parametric insurance products:

• Historical and current data about the relevant index (rainfall, wind speed, etc.)
• Predictive models of weather events, including emerging risks from climate change
• Risk assessment for your business facing the event and its severity
• The amount of your payout in the event of a claim

Parametric insurance is not a replacement for commercial insurance. Your policy pays the same amount if your office is destroyed in a flood, or unaffected. That's why you still need commercial property insurance or a business owner's policy (BOP) to cover your losses.

Both types of insurance can provide significant reassurance that your business personal property and investments are protected from potential risks so that you aren't vulnerable to either policy's exclusions.

You might consider parametric insurance solutions if:

• Your business depends on fast recovery after a natural disaster
• You operate in an area where traditional insurance has coverage gaps
• You're exposed to measurable, predictable risks

Parametric insurance policies are also highly customizable. You can choose to receive payouts depending on different levels of storm intensity, or events that happen at certain times. Because they pay out a set amount, they do not have deductibles.

Talking to a licensed insurance agent or broker can help you determine if this type of policy is a good fit for your needs.