AI Is Supercharging Parametric Insurance

Considering its 200-year history, parametric insurance has been slow to adopt, with conventional insurers regarding it as a niche proposition, suited for the hardest-to-insure exposures. Inflation and increased climate volatility are pushing insurance carriers out of admitted markets, forcing insurers, customers and governments to explore alternative risk management solutions, especially those powered by artificial intelligence. With market projections of $29.1 billion by 2032, this may be the moment parametric insurance has been waiting for.

As climate change-related disasters become more frequent and more devastating, and as traditional carriers continue to struggle with underwriting in areas rife with increasing losses, insurers are warming to parametric insurance. Parametric policies cover the probability of an event taking place, so that when a specific parameter has been triggered (let’s say a hurricane of a certain strength at a particular location), the policy automatically pays out a previously agreed to amount. However, because parametric payouts are predetermined, they are not based on actual customer losses. Basis risk is the term used to define this discrepancy—the difference between a policyholder’s actual financial loss and their ultimate insurance payout.

The pesky problem of basis risk may provide at least a partial explanation for the lag in parametric’s adoption over the years. However, today, AI solutions have the potential to minimize basis risk to the point of near extinction, paving the way for an explosion of novel hybrid products that combine parametric elements with the precision of traditional insurance coverage.

Risk Assessment and Modeling: AI algorithms analyze vast amounts of data from various sources, including historical weather patterns, sensor data, satellite imagery, and economic indicators. By processing this data, AI can accurately assess risk factors and model potential scenarios, enabling insurers to design parametric insurance products that cover a wide range of risks with greater accuracy.

Real-time Monitoring and Triggering: AI-powered systems continuously monitor relevant parameters in real-time. For instance, in agriculture, AI can track weather conditions, soil moisture levels, and crop health. If predefined thresholds are exceeded (e.g., drought conditions persist for a certain duration), the system automatically triggers payouts to policyholders, providing rapid financial assistance when it’s needed most.

Claims Processing and Verification: AI streamlines the claims process by automating claim submission, verification, and settlement procedures. Natural language processing (NLP) algorithms can extract relevant information from documents and images, expediting claims handling. This efficiency reduces administrative costs and ensures faster payouts to policyholders.

Customization and Flexibility: AI enables insurers to tailor parametric insurance products to the specific needs of individual policyholders or industries. Machine learning algorithms analyze historical data to identify unique risk profiles and adjust coverage parameters accordingly. This customization enhances the relevance and effectiveness of parametric insurance solutions.

Fraud Detection and Prevention: AI algorithms analyze behavioral patterns and anomalies to detect potential instances of fraud or misuse. By flagging suspicious activities in real-time, AI helps insurers mitigate fraud risks and maintain the integrity of parametric insurance programs.

Scalability and Accessibility: AI-powered platforms can handle large volumes of data and transactions, allowing insurers to scale their parametric insurance offerings efficiently. Additionally, AI-driven interfaces and applications enhance accessibility for policyholders, facilitating easy policy management and claims submission through digital channels.

Overall, AI is revolutionizing parametric insurance by optimizing risk assessment, automating processes, enhancing customization, and improving overall efficiency. As AI continues to evolve, parametric insurance will likely become even more sophisticated, offering greater resilience and protection against a wide range of risks in various sectors.