13 August 2025
Parametric insurance, a relatively new insurance mechanism that pays out upon predefined events rather than actual assessed losses, has been garnering attention as a potentially transformative tool for risk management. However, industry discussions have highlighted several notable barriers: basis risk, regulatory uncertainty, consumer awareness challenges, and data scarcity.
As a life and health insurance practitioner of over twenty years, reading about these challenges, I find many parallels to critical illness (CI) insurance, especially in CI insurance's early days. Hence, I thought to explore these parallels, and I hope that these personal thoughts of mine might help suggest some pathways for overcoming the current barriers to parametric insurance.
Basic Risk
Basis risk in parametric insurance refers to the potential mismatch between the predefined payout triggers and the insured's actual financial losses. Essentially, this is the risk that the parametric trigger's estimate of loss diverges from the insured's actual loss, causing under- or over-payment. This can create uncertainty and trust issues among consumers and regulators.
This concern closely mirrors the early CI insurance market, where insurers faced analogous challenges known as ‘definition risk'. Insurers initially struggled with claims being denied due to narrowly or ambiguously defined illness criteria, resulting in considerable dissatisfaction among policyholders. For example, early definitions of conditions like heart attacks and strokes were not standardised, causing inconsistent claim outcomes and customer complaints. In addition, CI insurance traditionally covered illnesses at a particular extent/stage, the definitional complexity of which may be difficult for the layman consumer to understand. I recall years ago, there was a case that turned up in the local newspapers as a lady was diagnosed with Stage 1 cancer and was informed that her CI insurance does not cover this, as her policy covers Stage 3 cancer.
The CI insurance market overcame this issue through both industry-wide standardisation of illness definitions as well as product innovation/flexibility.
The establishment of standardised definitions by professional bodies, notably the Association of British Insurers (ABI) in 1999, reduced disputes and increased trust among consumers, distributors, and regulators. The insurers also innovated and designed tiered benefit structures for their CI solutions, providing lower levels of payout for earlier-stage illnesses – for example, paying out 25% of the sum assured for stage 1 cancer, 50% for stage 2, and 100% for stage 3.
Adopting a similar approach, the parametric insurance industry could benefit from collaboratively establishing clear and transparent disclosure frameworks and common trigger-design principles. These measures would enhance predictability and build customer confidence, reducing hesitance related to basis risk. Tiered benefit structures are not uncommon in the parametric insurance realm, with some being proportional, i.e., a direct increase with the index. One notable recent example is the most recent SEADRIF policy for Lao PDR, a unique two-year, multi-peril cover that uses a government-reported, impact-based trigger—payouts are tied to the annual aggregate number of people affected recorded by the National Disaster Management Office. As pre-agreed thresholds are crossed, payouts are made within 10 business days. Earlier, Laos' 2024 SEADRIF flood renewal explicitly expanded its trigger from two to four levels, illustrating the tiered approach.
Regulatory Uncertainty
In discussions surrounding parametric insurance regulation, a recurring challenge involves the fundamental distinction between parametric products and traditional indemnity-based insurance. Regulators frequently grapple with classifying parametric coverage precisely because payouts are triggered by predefined events rather than actual documented losses – concerns that revolve around the concept of indemnity, traditionally a cornerstone of insurance regulation, designed to ensure that payout strictly correlates with verifiable financial losses. This is the case for jurisdictions where the general insurance doctrine is tied to indemnity.
In the life insurance space, as the “trigger” is typically related to human life or health, and hence, determined to be financially “priceles”, there weren't many similar concerns. CI insurance was pioneered by Dr. Marius Barnard, who recognised that patients who survived a major illness, such as a heart attack or cancer, often faced long recoveries, lost income, and sometimes out-of-pocket expenses with no lump sum benefit to help cover these financial needs. He worked with insurers in South Africa to develop an insurance product that would pay a lump-sum benefit upon diagnosis and survival of a specified serious illness, regardless of treatment costs or duration of recovery.
That said, initially, CI policies were viewed sceptically in some jurisdictions, given that lump sum benefits were paid upon diagnosis of an illness without explicitly requiring proof of actual medical expenses or financial loss. Regulators initially questioned whether these lump-sum payments might lead to moral hazard or speculative behaviour.
However, drawing on two fundamental concepts of insurable interest and financial underwriting in traditional life insurance, these concerns were resolved.
Insurable interest, a foundational principle of life and health insurance, stipulates that the policyholder must stand to suffer a genuine financial loss or disadvantage from the insured risk occurring. For CI insurance, insurable interest was clearly established through the direct relationship between the insured person's health condition and their personal financial vulnerability. Essentially, the insured individual or their direct family members inherently had an insurable interest, thereby satisfying regulatory requirements and alleviating concerns around potential speculative motivations.
Insurers also ensured robust financial underwriting frameworks for CI policies. Financial underwriting involved validating the appropriateness of the coverage amounts relative to the insured person's income and financial needs. Insurers systematically ensured that policy limits were proportionate and reasonable, thus preventing excessively high sums assured that could incentivise speculative behaviour.
Although parametric coverage addresses different types of risks—often related to natural disasters or systemic events rather than individual lives—the core regulatory principles remain similar. Demonstrating clear insurable interest—such as a farmer's inherent financial exposure to drought—should underpin the rationale for parametric products. Simultaneously, applying an analogous financial underwriting approach can ensure payout limits align sensibly with the genuine financial exposure or potential losses faced by policyholders. This process can alleviate regulators' concerns about payouts detached from actual losses, thus smoothing the path toward regulatory acceptance and product innovation.
Critically, while lives and disaster events are fundamentally different in scale, nature, and impact, the regulatory principles successfully deployed by CI insurance—insurable interest and robust financial underwriting—offer practical, proven pathways that parametric insurance stakeholders can leverage to provide some level of comfort to supervisors, although it is recognised that adopting these principles will not completely remove the classification friction.
Relatedly, regulatory treatment of parametric policies still varies across jurisdictions: some supervise them under general insurance law, others require legal opinions, sandboxes, or bespoke rules, and in a few places indemnity-style provisions (e.g., proof-of-loss expectations) meant that supervisors lean on general ‘contract of insurance' tests and case-by-case analysis. This unevenness can slow approvals and add operational friction.
CI insurance faced comparable regulatory fragmentation initially, particularly evident in multi-state markets such as the United States, where each state applied varying interpretations and rules. This inconsistency significantly slowed product rollout and hampered early adoption rates.
CI insurers addressed these regulatory inconsistencies through proactive, collaborative engagement with regulators. Industry stakeholders worked together through formal associations and regulatory bodies to create cohesive frameworks and more explicit rules, facilitating market entry and product innovation. A similar regulatory engagement strategy could be useful for parametric insurance.
Consumer Awareness
The inherent complexity of parametric products remains a barrier to consumer acceptance. Many consumers struggle to understand how a product pays out based solely on an event rather than actual documented losses. This lack of consumer understanding mirrors early consumer reactions to CI insurance, which initially struggled with low take-up rates because consumers found the products too technical and challenging to grasp.
The CI insurance market addressed consumer awareness issues by investing in clear communication strategies, clear product explanations (although with the complexities of CI insurance, this is still something that requires attention), and intensive distributor education. Compelling narratives were built around tangible financial relief (such as covering mortgages upon illness diagnosis), facilitating consumer understanding and increasing product appeal.
For parametric insurance, consumer acceptance could likewise benefit from focused educational initiatives. Straightforward, compelling storytelling that demonstrates direct, practical financial benefits—such as immediate liquidity post-disaster—can enhance consumer comprehension and, subsequently, product demand.
Data Scarcity
Parametric products depend heavily on the availability and reliability of event data, which informs trigger mechanisms. A lack of consistent, credible data challenges the development of credible, reliable indices/triggers, which complicates accurate product pricing.
The CI insurance industry initially faced analogous data scarcity issues, lacking credible morbidity data essential for product pricing and reserving. The industry responded through coordinated actuarial efforts to compile robust data sets and credible morbidity tables, notably the creation of standardised actuarial tables like CIBT93, enabling accurate, credible product pricing.
Drawing from the CI playbook, parametric insurers and reinsurers could similarly benefit from creating industry-wide collaborations to compile and share robust event data. Building a publicly accessible database of verified historical event data and payout outcomes would enhance market credibility and facilitate accurate product pricing and reserving.
Ultimately, CI and parametric insurance are vastly different insurance solutions with CI's ‘trigger' being based on human lives whilst parametric insurance's triggers can span across a wide range of elements/factors – from weather-related to number of lives affected. That said, the parallels between early critical illness insurance challenges and those currently confronting parametric insurance are notable and instructive. By leveraging the strategies that enabled CI insurance to evolve from niche product to mainstream protection mechanism—standardised definitions, product innovation, proactive regulatory collaboration, consumer education, and credible data compilation—the parametric insurance market can potentially enhance its acceptance, and scalability.
GAIP is undertaking a study into the parametric insurance space for Asia, examining the regulatory, operational and market demand and supply factors, to enable the scaling of this innovative insurance solution that is one of the key arsenals in the risk management toolboxes of individuals, families, businesses and governments.
