Pioneering risk management in a digital world

In an era defined by rapid technological advancement and increasingly complex risk landscapes, the insurance industry stands on the cusp of a revolution.

At the forefront of this transformation is parametric insurance, an innovative approach to risk transfer that promises to reshape how businesses and individuals protect themselves against unforeseen events.

At its core, parametric insurance represents a fundamental departure from traditional indemnity-based models. Instead of relying on complex claims assessments and a lengthy payout processes, parametric policies operate on a simple principle: if a pre-defined event occurs, the policy pays out.

While parametric insurance’s use cases at present focus on covering industries for increasing climate change threats such as wildfires and floods, as a result of the rise of technological advancements such as artificial intelligence (AI), the future of parametric insurance extends far beyond this, redefining the very essence of insurance in the digital age.

Instant response

In a world where cashflow can make or break a business, parametric insurance delivers unparalleled speed, with payouts triggered automatically within hours or days of an event, rather than weeks or months. As businesses navigate their digital transformation, they face emerging risks traditional insurance products struggle to address.

With cyber attacks on the rise, the UK has seen a significant increase in incidents. According to the National Cyber Security Centre, there was a 64% increase in cyber incidents reported by UK organisations in 2023 compared with the previous year.

Business continuity is critical in such cases; otherwise, with operations down, organisations can experience huge financial losses, especially in time-sensitive industries such as banking and telecommunications. Traditional insurance models often struggle to keep pace with the rapidly evolving nature of cyber threats, requiring time-consuming processes to report and prove the incidents.

Parametric insurance will revolutionise online security by triggering instant payouts the moment a data breach or cyber attack event takes place meaning organisations receive immediate financial support to fuel their business recovery efforts.

At the same time, this benefit has the potential to be broadened to a wider digital risk universe, with instant payouts triggered in cases of sudden spikes in malicious traffic or even the detection of certain types of malware within the network. For example, personal cyber insurance is expected to become a significant product line in the coming years, enabling individuals and families to protect their online assets, including photo and video archives, legal documents and other valuable digital property.

AI at the forefront

From risk identification to final claims calculation, AI is transforming parametric insurance processes across various risk pillars, including financial, physical and digital risks.

The main value lies in reducing the need for manual risk assessment and automating the claims calculation process. Risk assessment is a demanding and time-consuming process requiring accuracy and strict adherence to detail.

At present insurers need to identify, assess, treat and report risks before they can calculate the claim. However, an AI-driven risk assessment allows insurers to analyse vast amounts of data in just a few seconds from diverse sources, identifying patterns and correlations that might be missed in the traditional process. Thanks to this, insurers can create more accurate risk profiles for their clients and design parametric triggers that more closely match real-world loss events.

From risk identification to final claims calculation, AI is transforming parametric insurance processes across various risk pillars, including financial, physical and digital risks. The main value lies in reducing the need for manual risk assessment and automating the claims calculation process

Moving to claims calculation, where AI also plays a central role, it becomes clear parametric insurance can benefit insurers as well. Specifically, AI enables claims to be automated by pre-determining parameters and payouts in advance, reducing the need for a large claims team to assess whether an incident is covered. Similarly, there is no longer a need for loss adjusters to minimise the payout to a level the customer will accept, as all terms are agreed upon up front. This shift places additional responsibility on actuaries to ensure risks – both their probability and severity – are accurately assessed and adequately priced.

Balancing innovation with regulation

However, AI cannot guarantee the quality of the initial data input. As parametric insurance continues to evolve and expand into new areas like digital risk, collaboration among regulators, insurers and relevant stakeholders is essential to address such emerging challenges. This co-operation is crucial for developing robust frameworks that can adapt to rapidly changing digital-driven insurance landscapes.

The biggest challenge is the quality of the initial data selected for the risk assessment, triggers and claims calculation. To ensure parametric triggers are fair, transparent and accurately reflect the actual risk exposure, the initial data must be of the highest possible quality. At the same time, access to quality data must be balanced with respect to data privacy and relevant laws such as the EU’s GDPR, especially when it comes to emerging digital risks like cyber attacks.

Ultimately, the goal should be to create a landscape that encourages innovation in parametric insurance while maintaining consumer protection and market stability. This may involve creating regulatory sandboxes where new parametric products can be tested under controlled conditions or developing principles-based regulations that are flexible enough to accommodate rapid technological change.

Additionally, industry-wide standards for data collection, validation and sharing could be established to ensure consistency and reliability across different parametric insurance products.

By striking the right balance between innovation and regulation, the insurance industry can harness the full potential of parametric insurance to provide faster, more efficient and more tailored risk protection in our increasingly digital world.

Thomas Swift is principal at Elixirr