Parametric insurance – a possible solution to Ireland’s Nat Cat risk?

In the last issue of ALG’s ESG & Sustainability bulletin, we discussed what insurers could do to combat climate risk and the protection gap in light of recent extreme weather events at home and abroad.

In this article, we consider the possible future use of parametric insurance as a solution for these growing problems.

The complexity of traditional natural catastrophe (Nat Cat) insurance coverage means that it can take considerable time to process claims and issue sums to policyholders for losses sustained as a result of adverse weather events.

In a world where climate change is poised to increase the frequency and severity of natural disasters in Ireland and across the globe, parametric insurance may be an innovative alternative to traditional insurance products.

What is “parametric insurance”?

In its Staff Paper on Measures to Improve the Insurability of Business Interruption Risk in Light of Pandemics, the European Insurance and Occupational Pensions Authority (EIOPA) describes parametric insurance as “a type of insurance covering the occurrence of a pre‐defined external event, instead of indemnifying the actual losses incurred by the policyholder”.

Unlike traditional insurance, which requires claims to be assessed and paid based on the extent of loss or damage suffered by a policyholder, parametric insurance uses predefined parameters to trigger compensation automatically. For example, a payout could be triggered if a national meteorological service records wind-speed, temperature or rainfall of a certain magnitude in a certain area, without requiring an assessment of damage or loss suffered by a policyholder.

The EIOPA Staff Paper noted that traditional insurance does not suit the urgent relief requirements of policyholders in Nat Cat events. The parametric model, in theory, significantly reduces claims processing times because there is no requirement to assess damage or loss; all that is required for payment is that a specific event has occurred. This should lead to faster payouts and more cost efficiencies for insurers and policyholders alike, in particular following Nat Cat events that typically see claims made in high volumes in short periods of time, sometimes accompanied by regulatory or political pressure to pay quickly, without adequate opportunity to assess loss or damage.

Applications of parametric insurance

EIOPA’s report on the digitalisation of the European insurance sector published in April 2024 (the EIOPA Report) found that approximately 10% of insurers in the EU offer parametric insurance products, with 80% of insurers surveyed indicating that they had no plans to develop parametric products in the next three years. However, parametric insurance continues to be a particularly useful tool in manging risk relating to Nat Cat and is gaining traction in areas prone to Nat Cat events.

In the global south, parametric products are growing in popularity in an effort to stabilise agricultural industries amid increasingly turbulent weather. For example, a parametric insurance policy could provide swift and automatic payments to policyholders whose crop yields are at risk of being diminished due to extreme weather events such as drought or high levels of rainfall. Parametric insurance can mitigate the damage caused by such extreme weather events and protect policyholders from significant income loss.

This is also the case for risks like business interruption. Parametric triggers can ensure speedy and simple claims analysis and payouts which can mitigate the effects for businesses of any economic loss, such as loss of footfall.

There is no doubt that current Nat Cat trends along with the complexity associated with assessing damage and loss after Nat Cat events means there is a growing demand for parametric products globally. With the ever-increasing impact of adverse weather events in Europe, parametric insurance products could become an effective and innovative solution for the European market.

In light of the EIOPA Report’s findings that a minority of insurers are considering meeting this demand in the short term, there is real growth potential for insurers looking to move into this space.

Use in Ireland

As we noted in a previous article, the Central Bank of Ireland (CBI) published its Flood Protection Gap Report in October 2024 (the CBI Report), which noted the shortfall between insured losses and economic losses arising from extreme flooding events in Ireland. The CBI further stressed that recovery by Irish homeowners and businesses from flooding events has been impaired by a lack of access to appropriate insurance coverage. Nat Cat protection gaps have emerged at an EU level also, with EIOPA estimating that only 35% of climate related losses are insured across the EU[1].

With Irish communities expected to experience extreme flooding events into the future, and with the flood protection gap on the CBI’s agenda for 2025 and beyond, parametric insurance could be an innovative solution to this ever-increasing problem. We analyse the benefits and challenges of parametric insurance below.

First, one potential stumbling block is that it is not clear in Ireland whether parametric insurance products fall within the traditional classes of insurance underwritten by insurers. As there is no definition of “insurance” available under Irish legislation, there is potential uncertainty as to whether Irish insurers can underwrite parametric insurance products. Insurers would benefit from clarification of the applicable legal rules.

Benefits…

• Improved speed of claims processing is a key benefit of parametric insurance model products. EIOPA has previously provided general figures indicating that while parametric relief can be paid out in the immediate aftermath of an event, relief under traditional policies can take up to (and beyond) nine months[2]. As compensation is triggered when an event occurs, not once damage relating to an event is sustained, reported and verified, compensation can be paid automatically.
• Transparency and simplicity of coverage also make parametric insurance products attractive. As products are based on objective pre-determined factors, time and subjectivity in processing claims is reduced and coverage is easier to confirm in short timeframes, lending to a fairer process for policyholders and lower claims management costs for insurers.
• Simplified risk assessment for insurers has the potential to increase availability of cover. As parametric products provide a predetermined payment on the occurrence of an event, insurers do not have to forecast the likely economic loss from an event. Instead, insurers can concentrate on the risk of an event occurring at a particular location during the period of cover. According to some commentators, this may encourage insurers to cover risks that they would not otherwise be prepared to cover, particularly risks that almost meet insurers’ criteria for traditional cover.

…and challenges

Despite its promising advantages in Nat Cat protection, there remain some hurdles to the widespread adoption of parametric insurance:

• Accuracy and reliability of the data relied on to create the parameters is of paramount importance to ensure appropriate coverage and fairness for policyholders and appropriate risk management for insurers. Until such data sources are sufficiently reliable, there is a risk that compensation will not align with the needs of policyholders or that insurers will misprice risk.
• Technology supporting full automation of parametric policies is not yet fully developed. Insurers in this space are therefore still favouring hybrid traditional / parametric products.
• Parametric insurance does not cover all types of risk. Losses relating to factors falling outside the pre-determined metrics of parametric insurance will not be compensated. In some cases, policyholders may still require traditional insurance to ensure complete cover.
• The parametric model depends on accurate and clear triggers to mitigate the risk of cover being too narrow or too broad. EIOPA has highlighted that the simpler a parametric trigger, the less likely it is to match any related losses[3]. This will be an important challenge for insurers looking to build parametric offerings.

What next?

The parametric insurance industry is poised for growth in Nat Cat cover as adverse climate events increase in severity and frequency across the globe.

There is potential for the model to be implemented in Ireland to help to address the nation’s flood risk. With its various attractions including speed and efficiency compared to traditional insurance, there is an opportunity for Irish insurers to market parametric coverage to a new generation of policyholders demanding quicker and more cost-effective insurance solutions.

There is some way to go before there is certainty as to the role and function of parametric insurance products in the Irish and wider EU market, but there is no better time than now to shift the focus to alternative solutions to climate change risks.

For advice or for further information on this topic please contact James Grennan, Partner, Adam Assahli, Senior Associate, Catherine Moloney, Solicitor, or any member of the A&L Goodbody Insurance & Reinsurance team including Laura Mulleady, Partner, Sinéad Lynch, Partner and Emma Martin, Of Counsel.

Date published: 17 February 2025