Climate & Parametric Risk Products
Glossary
- Attachment point
- The index level at which a parametric policy begins to pay. Set too high, it leaves a band of uncompensated loss (deepening negative basis risk); set too low, it pays for frequent small events and inflates premium. It should sit near where the facility's losses actually begin.
- Basis risk
- The difference between what a parametric policy pays and what the buyer actually loses. It is inherent to the product because every index is a proxy for loss. It runs in two directions: negative (loss suffered but no payout — the dangerous direction) and positive (payout with little loss — a windfall).
- Catastrophe bond (insurance-linked security)
- A capital-markets instrument in which investors accept a defined risk of losing principal if a specified index crosses a specified trigger, in exchange for yield. It lets parametric climate risk be funded by bond investors seeking uncorrelated returns, providing capacity when traditional reinsurance retreats.
- Indemnity insurance
- Traditional insurance that reimburses documented, assessed physical loss to a specific insured item, making the buyer whole for the itemized damage. Thorough but slow and administratively heavy — the complement parametric cover is layered against.
- Index
- The measured, objective quantity a parametric contract watches — for example sustained wind speed at a named station, cumulative degree-days, or a river gauge reading. It must come from a source neither party controls or can manipulate.
- Insurability zone
- A geographic area characterized by whether adequate insurance for its perils can be secured at a viable price. As climate exposure rises, insurers ration or withdraw capacity from the most exposed zones, potentially rendering otherwise viable sites uninsurable and therefore unfinanceable.
- Parametric insurance
- Insurance that pays a pre-agreed amount when an objective, independently measured index (such as wind speed, temperature, or water level) crosses an agreed threshold, rather than paying on an assessed physical loss. This enables fast, dispute-free settlement but introduces basis risk.
- Trigger
- The threshold (or schedule of thresholds) at which the index obligates a payment. Triggers may be binary (fixed payout at one line), stepped (payouts in tranches), or linear (proportional payout between attachment and exhaustion points).