Climate change is making extreme weather worse and, right now, Americans are paying the price.

Over the past two years, wildfires in California, floods along the Mississippi River and hurricanes in the Southeastern United States have caused tens of billions of dollars in damage. In 2018, weather-related catastrophes prompted $215 billion in losses across the globe, according to a January 2019 report from Aon,

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 a global insurance and reinsurance firm. That was well above the inflation-adjusted average since 2000. Aon said 2018 wasn’t even the costliest year on record. That honor goes to 2017, when weather events caused a total economic loss of $438 billion.

‘The one industry that’s not debating the nature of climate change is the insurance industry.’

—Ruth Foxe-Blader, managing director at Anthemis

“The one industry that’s not debating the nature of climate change is the insurance industry,” said Ruth Foxe-Blader, a managing director at venture investment firm Anthemis and an insurance-industry veteran. “The insurance industry woke up really hard and really fast to the weird weather we’ve been having. We keep having 100-year storms within a few years of each other.”

Of the $215 billion in economic loss caused by weather-related catastrophes in 2018 globally, less than half was insured, highlighting a dilemma that many Americans are experiencing in their everyday lives. In the U.S. real-estate market in particular, there’s a major protection gap. Flood damage is excluded from standard homeowner’s insurance policies, yet only 15% of American homeowners had a flood insurance policy as of 2018, according to the Insurance Information Institute.

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As the insurance industry grapples with covering the growing losses these extreme weather events cause, the cost of policies is becoming prohibitive, worsening the protection gap. A solution may come through a relatively new form of property-casualty insurance that only recently began being sold to homeowners: Parametric insurance.

What is parametric insurance — and why is it well-suited to climate change

Unlike traditional casualty insurance that reimburses a policyholder for the cost of damage incurred to property, parametric insurance covers the probability of some event happening that is likely to cause an economic loss.

Here’s how that works: Parametric policies require pre-defined events to occur for a consumer to receive a payout. The event itself doesn’t trigger a payout, but insurers will issue payouts if a certain threshold is met; for example, if a storm reaches a certain intensity level. Some policies are based on an honors system, others will automatically issue a payout, experts say.

Parametric insurance is not unlike life insurance, which pays a predetermined amount based on a triggering event, the policyholder’s death.

Events can include everything from hurricanes and floods to droughts and earthquakes. The trigger could be something as simple as the category of storm or the amount of precipitation. For instance, if a homeowner purchased a parametric insurance policy to cover earthquake damage, the insurer could set a threshold of where on the Richter scale an earthquake must fall in order for a homeowner to receive a payout.

As a result, parametric policies can be designed with climate change in mind. A policy could pay the owner of a beach-front property a certain amount if sea levels were to rise another few inches.

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There’s one major quirk to parametric insurance that may seem unusual to those familiar with more traditional property insurance: The homeowner doesn’t necessarily need to experience any damage to get a payout.

For instance, if a family’s home doesn’t sustain damage in a Category 3 hurricane, but they had a parametric policy that triggered a payout when a Category 3 hits, they may receive a windfall. (On the other hand, if an insurer sets a very stringent parameter, a homeowner could go without an insurance payout if the weather event wasn’t severe enough even if they incurred damage to their property.)

It helps to think of parametric insurance as akin to life insurance. A life-insurance policy pays a predetermined amount based on a triggering event, the policyholder’s death.

Unlike traditional property-casualty insurance, parametric policies typically don’t have exclusions, deductibles or require adjusters to assess damage.

Unlike traditional property-casualty insurance, parametric policies typically don’t have exclusions, deductibles or require adjusters to assess damage. Because payouts are triggered by a discrete event, the payouts can happen almost immediately.

“In a world where the climate is becoming more and more uncertain, the certainty offered by parametric products can be incredibly powerful and make communities more resilient,” said Matthew Jones, a principal at Anthemis and an insurance industry veteran.

Parametric insurance, also known as index-based insurance, is a relatively new product. The first concept for index insurance was developed in the 1920s by Indian economist J.S. Chakravarti to provide insurance for farmers based on rainfall amounts, according to the International Finance Corporation. Farmers in Sweden began experimenting with this type of insurance in the 1950s, and it came to the U.S. in 1993.

Beyond agriculture, parametric insurance has been the domain of institutions and governments. The State of Louisiana has a parametric policy that pays up to $1.25 million to the state if it is hit by a named storm with sustained winds of at least 80 miles per hour. And the government of Quintana Roo in Mexico has purchased a parametric policy for the coral reef around Cancun and Puerto Morelos that would pay out if the area the reef is located in is hit by a hurricane.

Floridians can buy parametric hurricane insurance

A few companies have begun to offer direct-to-consumer parametric products designed as supplements to traditional insurance policies.

One of those firms is Silicon Valley-based Assured Risk Cover, which offers a product called StormPeace that provides insurance coverage for hurricanes in Florida. The company was founded in 2017, and its product has received the stamp of approval from insurance regulators in the Sunshine State.

A homeowner with a $6,000 StormPeace policy would likely pay an annual premium of approximately $390 to $420.

Alok Jha, CEO of Assured Risk Cover, said people don’t always get the money their due in a timely manner after a disaster. “Our desire was to get cash into the hands of the individuals almost immediately in the aftermath of a catastrophe,” he said.

StormPeace pays out claims on a graduated basis, based on the severity of the storm. It determines the payout using two metrics: the strength of the storm and the distance between the insured property and the storm’s track. Assured Risk Cover uses data from the National Hurricane Center to make its calculations.

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When a storm hits an area where Assured Risk Cover provides coverage, the company will send an automated email to potentially affected policyholders notifying them of how much they are entitled to in terms of a claim. Each person can then reply to the email to attest that they need a payout because of the storm, and then Assured Risk Cover will send them the money, Jha said.

How much a StormPeace policy costs varies based on how much coverage a homeowner wants. Most homeowners purchased enough to cover the hurricane deductible on their traditional homeowners insurance policy. Jha said most home insurance policies have around a 2% hurricane deductible.

After Hurricane Irma in 2017 and Hurricane Michael in 2018, Assured Risk Cover said it paid most claims from parametric policy holders within 24 hours.

Based on the coverage amount selected, StormPeace charges a premium that ranges between 6.5% and 7% of the coverage amount, Jha said. So someone who buys a $6,000 policy for their home might pay a premium of $390 to $420 per year. (Jha declined to provide the average cost of policies provided by Assured Risk Cover.)

Since the product was launched in 2017, two hurricanes have made landfall in Florida: Irma in 2017 and Michael in 2018. All of the claims from both storms have been paid out, Jha said, and most payouts occurred within 24 hours of when each storm hit.

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Paying a claim quickly following a catastrophe is critical. “Imagine a hole in the roof,” Jha said. “If money’s not paid to them right away to fix that roof, water gets in and then mold accumulates.”

Getting a payout quickly in theory allows the homeowner to begin repairs right away and avoid worse damage.

Getting a payout quickly in theory allows the homeowner to begin repairs right away and avoid the damage getting worse. When that effect is multiplied across multiple homes within a community, it can play a major role in preventing a disaster from causing widespread ruin.

Jha points to New Orleans after Hurricane Katrina as an example of how the current insurance paradigm can fail communities. Many people lacked insurance to cover the losses the storm’s torrential flooding and storm surge caused. Those who were lucky enough to have insurance had to wait for the claims adjustment process to happen before they received their money.

These factors, Jha said, contributed to the permanent exodus of many residents from the city. “If a recovery happens quickly, people get back on their feet and get back to their jobs quicker,” Jha said.

How parametric-style insurance could benefit the insurance industry

Industry experts argued that parametric policies could help close the existing protection gap among consumers, even if they are just supplemental policies.

As of today, most parametric policies are not designed to cover the total value of a property. While a drawback potentially for consumers who might lack other insurance coverage, that generally makes them a more affordable product because insurance companies can charge a lower premium given the lower risk.

“It’s a way of increasing take-up rates,” said Christopher Hackett, underwriting regulation analyst at Zurich North America

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an insurance company. “They may not be fully indemnified for the loss, but they’ll at least have some money to help them.”

‘It’s less expensive to offer these products because there is no formal claim adjustment process.’

—Christopher Hackett, underwriting regulation analyst at Zurich North America

For insurance companies, parametric policies have a separate set of benefits — namely, they are cheaper to offer than traditional homeowner’s insurance policies.

“From the insurance company’s perspective it’s less expensive to offer these products because there is no formal claim adjustment process,” said Hackett, who previously was senior director of personal lines policy at Property Casualty Insurers of America.

Because parametric policies rely on data to approve payouts, there’s no need to maintain a large staff of claims adjusters. Assured Risk Solutions doesn’t employ any claims adjusters in fact, Jha said. “We have software developers, who have been in the risk-modeling industry and data scientists,” he said.

Companies could also consider a hybrid home-insurance policy to shorten the claims-review timeline, Jha said. The typical claims-adjustment process could be eliminated thanks to new technology, he said. Drones are one way to speed the process, he added, enabling human cost adjusters for the most difficult or costliest of claims.

Parametric insurance’s drawbacks

Parametric insurance policies are not without downsides. Perhaps the biggest is so-called basis risk — the potential that a policyholder could incur a loss without the necessary trigger being met.

Let’s say a tree falls on a home during a storm with 25 mile-per-hour winds, but the homeowner’s policy requires the storm to have wind speeds of at least 30 miles per hour to issue a payout. In that situation, the homeowner wouldn’t receive a payout, despite having a parametric policy.

Parametric insurance cuts both ways: a policyholder could incur a loss without the necessary trigger being met.

The basis risk posed by a given parametric policy can be higher if the insurance company is relying on less reliable data.

A 2010 study of a parametric-style insurance product for farmers in India centered on rainfall amounts found that the product proved less popular among farmers who were located further from stations where rainfall amounts were measured. The insurer used the data from these stations to determine payouts.

These farmers’ disinterest in the parametric insurance policies reflected their concern that the location of their farm and the land’s topography could exacerbate the effects of a major rainstorm, but that the nearest weather station may not reflect that.

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In this case, the data being used to trigger payouts was “noisy,” Jha argued, meaning it wasn’t robust enough to be easily interpreted for the purposes of paying out policies. “If you use a noisy parameter to pay a claim, that’s where the problems happen,” Jha said.

Assured Risk Cover avoids that issue by using the macro-level data from the National Hurricane Center. Hurricanes behave in more predictable ways — for instance, a tropical storm is going to weaken when it passes over land, not strengthen.

Many people don’t recognize the consequences of climate change

Experts say there’s a need to rethink traditional insurance. Much of the public has yet to reckon with the realities of climate change and realize that it will ultimately affect their lives and property, said Andrew Hoffman, a business professor at the University of Michigan.

Only 30% of the flood damage caused by Hurricane Harvey in 2017 was covered by insurance.

Making matters worse — insurance can be very expensive, and it’s not comprehensive. In particular, traditional homeowners insurance does not cover flood damage. For that, you need a separate policy.

On average, flood insurance policies purchased through the National Flood Insurance Program cost $700 per year, but that figure can go much higher depending on a home’s flood risk. And consumers have few options for flood coverage — very few companies provide private flood insurance.

The combination of these factors means that when disaster strikes in the form of a flood — a more common occurrence, meteorologists say, thanks to climate change — most homeowners are on their own.

Hurricane Harvey caused an estimated $37 billion in flood-related residential real-estate losses thanks to its storm surge and a devastating amount of rain the storm unleashed on Texas and Louisiana, according to real-estate data firm CoreLogic. It is estimated that 70% of that damage was not covered by any insurance.

But the industry may have a challenge getting people to take note. “One of the challenges of climate change is making it personally salient,” Hoffman added. “I can’t see greenhouse gases, and I can’t feel the global temperature go up.”

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