Parametric insurance

Parametric insurance is a type of insurance that does not indemnify the pure loss, but "ex ante" agrees to make a payment upon the occurrence of a triggering event. The triggering event is often a catastrophic natural event which may ordinarily precipitate a loss or a series of losses.

Transaction cost

Parametric insurance may reduce transaction costs involved in writing and administering insurance policies because there is less need for actual loss assessment for payment of claims or underwriting rating requirements to determine the premium based on liabilities and extent of risk sharing.

Application

Parametric insurance is ideal for low frequency but high intensity losses as in catastophic perils, weather related risks in agriculture or other economic activities, and risks sought to be covered without sufficient past history of losses captured as insurance readable data.

Users

For example, the Multilateral Investment Guarantee Agency covers hurricane risks based on category parameters and the World Bank designs earthquake parametric insurance based on the rigour parameter of earthquake on an appropriate measuring scale. National Insurance Academy in India propounded the concept of parametric life insurance premium setting based on variations in mortality table rather than setting constant level premium, which results in wide scale surrenders on improvements in mortality table due to better life expectancies at various age layers.

Another application of parametric insurance propounded by K C Mishra of National Insurance Academy, India is for managing risks of island dwellers. Usually islands depend on supplies from mainland or mainlands. If there is a parametric hazard in the mainland, the island dwellers suffer from supply bottlenecks leading to financial loss of debilitating dimensions. In such cases an index of parametrization is warranted if there can be supplies from multiple mainlands. Such improvization is better known as transinsurance rather than pure form parametric insurance.

Transurance

Transurance is an innovation at non-catastrophic levels akin to parametric insurance at catastrophic level according to K C Mishra, the Director of National Insurance Academy, Pune, India. Although businesses spend huge amount annually on property and casualty insurance premiums (In 2005-06 this amount may exceed 1500 billion dollars globally), insured loss recoveries are becoming a smaller portion of the economic costs of insured events. In effect, losses that are collateral to insurable events are becoming larger.

Transurance eliminates complex coverage definitions and loss adjustment processes by defining its coverage as a percentage of the loss recoveries under selected traditional insurance policies. This approach enables the insured to express its view of the relationship between insurable losses and collateral losses as a proportion of the underlying loss recovery.In short, Transurance makes uninsurable losses insurable, in a way that is effective and efficient, and helps insureds deal with the full impact of loss events. By supplementing insurance with Transurance, insurance recoveries will more closely resemble the total economic loss of insured events. Transurance may be substituted for ambiguous policy wording in traditional insurance so as to eliminate coverage disputes.

For the insurer, Transurance represents an opportunity to write more insurance with less transaction costs, since the underwriting effort is minimal and claims adjustment expenses are all but eliminated. The transparency, liquidity, and accessibility are the features Transurance wants to achieve for relatively opaque collateral losses.

To Transure collateral losses, a company must create a relationship between the amount of collateral losses and the size of the insurance recovery it is likely to receive. For example, if a company believes it will have uninsurable collateral losses equal to 20% of the amount it recovers from its insurance policy, it can purchase a Transurance policy that pays 20% of the amount that its insurance policy pays to create a budget for collateral losses.

Transurance enables the insured and the insurer to agree in advance how large the collateral losses will be in relation to the amount of the proceeds from an underlying property or casualty policy. By predefining this relationship, business continuity costs that are coincident to insured losses but aren't covered by traditional insurance because they are too difficult to define or substantiate can now be insured.

In an interdependent economy where supply is on demand, not stockpiled, the adverse effects of large property and casualty losses are frequently magnified and systemic. Absent immediate assurance of business continuity, stakeholders will disengage and form other business relationships. Providing assurance requires financial resources that go beyond traditional insurance. Transurance gives companies an opportunity to leverage the financial efficiency of conventional insurance and helps assure business continuity.

Parametric Insurance and Transurance are complementary. Transurance usage is likely to step out of property and casualty insurance to all areas of insurance, reinsurance and even life insurance and annuity insurance.