It is almost impossible to talk about blockchain and insurance and not mention parametric insurance. While the blockchain technology is capable of making insurance smoother and more efficient, it would be no exaggeration to say that blockchain and parametric insurance are made for each other. So, what is parametric insurance and what problems does it solve? Is there any catch? Let’s find out!
Parametric, also known as index-based, insurance compensates an insured when agreed-upon parameters are met. Essentially, it is an if/then contract for insurance. If a certain parameter is satisfied (e.g., a flight delay of 2 hours) then the policyholder receives a predefined pay-out. The diagram below illustrates it beautifully
Source: The Digital Insurer
While the same insurance contract can be done without blockchain but what blockchain and the smart contracts bring are transparency and reliability. Once the smart contract is written, it cannot be changed and the presence of “oracle” ensures that the claim is triggered without manual intervention. The “oracle” is essentially a program that checks for the event (in this case flight delay) at regular intervals and triggers the smart contract if and when the threshold is hit.
The flight delay insurance is one of the neatest examples of parametric insurance. However, there are several more use cases that have been out there in the market for a while now. The other popular applications include crop insurance based on rainfall index and earthquake insurance wherein the claim amount is based on the severity of earthquake (which in turn is based on Richter scale). In the most recent developments, a parametric insurance cover for coral reefs was launched. The payout would be based on the intensity of the hurricane.
Now that we have a flavor of parametric insurance, let us dig deeper to understand what are the key problems it solves. Firstly, it removes ambiguity around the payment of claims on both counts i.e. whether the claim would be paid and how much amount would be paid. The claim becomes payable as soon as the threshold is hit and the claim amount is pre-agreed. Secondly, it reduces the claim settlement time as there is no manual intervention involved to verify the claim. This also means that it makes offering cover in remote areas possible efficiently. For example, offering crop insurance in remote places of countries like India and Africa is now possible without incurring the high cost to verify the claim event.
This all looks great but where is the catch? Well, the interesting thing about parametric insurance is that it may not necessarily indemnify the insured against the damage. The claim amount could be more or less than the actual damage. Sample this, the intensity of the earthquake is 8.5 on the Richter scale and threshold limit for the claim is 8. The pre-agreed claim amount of $1000 is paid but the damage is of the order of $2500. The insured is then required to pay the difference from out of pocket! The opposite is also true wherein the insurer pays more than the actual losses! In effect, parametric insurance delinks the loss amount and claim amount. However, it does it on a parameter that is a good indicator of losses!
Before I sign-off, I wish to draw your attention towards the not-so-obvious advantages of the blockchain based parametric insurance. Parametric insurance on the blockchain is just the first step in innovation for the industry and demonstrates the power of blockchain in solving insurance problems and/or making the value-chain efficient. This should and in many ways, it has already led to several other innovations.
I hope that you found this article helpful and now have a flavor for parametric insurance Should you have any questions on these or insurance, in general, please do reach out to us at info@fidentiax.com.
Disclaimer: The article has been written with an aim to broadly explain an otherwise complicated and technical topic for readers with little or no insurance background. Hence, it doesn’t have finer details but is still broadly correct. The readers are recommended to take advise from their respective financial advisers before taking any financial decision.
