As they say, necessity is the mother of innovation, and as the real estate insurance market became even more competitive this year, homeowners began looking for alternatives to real estate insurance. Parametric insurance is one of those solutions.
Parametric insurance can help property owners and operations reduce risk and minimize policy costs, by offering property owners a predefined payout based solely on the extent of local weather or an earthquake event, as opposed to covering the damage caused by the event.
Parametric insurance is not for every asset. It is an insurance program designed to fill gaps that exist in the traditional insurance system. Nor is it designed to stand alone. But it can protect outdoor cannabis growers from weather risks that are really out of their control.
In today’s hard real estate market – in which rates are rising, signing criteria are stricter and insurers are writing fewer policies – parametric insurance is a great option for specific homeowners.
How Parametric Policy is Adapted to Specific Hazards
A parametric policy is fully paid when the so-called hazard reaches an agreed threshold based on a metric of a national weather organization approved by an airline. The payout is distributed completely regardless of the actual damage caused; it does not require claim registrations or for insurance regulators to review the website.
Parametric policies are tailored for a specific hazard that owners possess. In the Midwest, this could be a tornado measuring F3 or more; in the southeast, there could be a hurricane reaching category or wind speed. While parametric policies are paid, no matter how much damage property suffers, the policies are written with strict geographical parameters, so a natural disaster without undamaged property is rare.
Because parametric insurance is tailored to the specific risks of each real estate portfolio, it allows building owners and operators to set the terms and conditions. As a result, real estate investors with multiple properties in one area may be able to pool risk by purchasing a single parameter policy. For example, if a hotel chain has multiple properties within a one- or two-mile radius, a single parametric policy could cover all properties.
Advantages of Parametric Insurance Coverage
Although the cost is higher than traditional property coverage, a parametric policy offers a number of advantages including:
- Because a parametric policy fulfills the unique risk profile of the facility or real estate portfolio it results in a credit to the primary property policy; the parametric policy already covers the risk of property damage of a given danger like storms.
- Because there is no advertising, an accelerated payout allows property owners and operators to perform the duties of their loss immediately and they can continue operations or reopen quickly. The speed with which payments can have a significant impact on disaster victims. Companies insuring against business disruption risk and agencies provide an ancillary benefit, as resources can be deployed more quickly post-disaster.
- Owners and operators can use a reward to cover business interruption costs. For example, say hurricane results in a parametric reward, even though the storm leaves rental property covered by the policy. The owner can use the reward to cover forgotten expenses as customers cancel reservations.
- Because the amount of payment does not affect the total loss, the insured still has an incentive to minimize his losses. This reduces the exposure of the insurance company to the problem of moral hazard.
- The risk of insurance fraud is also reduced for larger contracts, as payment is standardized and the event is large-scale and independently controlled.
- Parametric insurance can reduce transaction costs involved in writing and managing policies because there is less need for an actual loss estimate for payment of claims or insurance rating requirements to determine the premium based on liability and scope of risk sharing.
Many factors determine the cost of parametric insurance coverage, including location, risk exposure, desired limits, and trigger parameters. Because parameter policies are highly tailored, property owners and operators will want to work with their broker to help set optimal parameters for coverage.
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