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K C Mishra says transurance and parametric insurance are the two faces of the future.

One of the top ideas of 21st century is disruptive technology. Look at erstwhile click-brand cameras like Yashica. Such cameras continue to perform efficiently, but is rendered useless by the advent of digital camera. Continuing to perform efficiently as before is no assurance for existence. That is the threat posed by disruptive technology.

For ages, general insurance thrived on the concept of pure loss indemnification. There cannot be an insurance without insurable interest and the insurer only compensates real loss, thereby ensuring that no insured can make profit out of insurance.

But events and business models of the 21st century have forced insurers to rethink. Two sharp disruptive technologies are making global rounds. They are parametric insurance and transurance. Such technologies are yet to enter headlong into the race course of Indian general insurers, but the National Insurance Academy has made valiant effort to introduce at least parametric insurance through the Agricultural Insurance Corporation of India Ltd, without maning any fuss about it. Most weather insurances are parametric or transurance.

Parametric insurance does not indemnify pure loss, but ex-ante agrees to make a payment upon the occurance of a triggering event. The triggering event is often a catastrophic natural event which may ordinarily precipitate a loss or a series of losses. Parametric insurance may reduce transaction costs in writing and administering policies, because there is lesser need for actual loss assessment for payment of claims or underwriting rating requirements to determine the premium.

Parametric insurance is ideal for low frequency, but high intensity losses as in catastophic perils, weather-related risks in agriculture or other economic activities, and risks sought to be covered without sufficient past history of losses.

For example, the Multilateral Investment Guarantee Agency covers hurricane risks based on category parameters and the World Bank designs earthquake parametric insurance based on the rigour parameter of earthquake on an appropriate measuring scale.

Transurance is an innovation at non-catastrophic levels, akin to parametric insurance at catastrophic level. Although business world spends huge amount annually on property and casualty insurance premiums (in 2005-06, this amount may exceed $1,500 billion globally), insured loss recoveries are becoming a smaller portion of the economic costs of insured events. In effect, losses that are collateral to insurable events are becoming larger.

Transurance eliminates complex insurance coverage definitions and loss- adjustment processes by defining insurance coverage as a percentage of the loss recoveries under selected traditional insurance policies. Transurance makes uninsurable losses insurable, in a way that is effective and efficient, and helps the insured deal with the full impact of loss events.

By supplementing insurance with transurance, insurance recoveries will more closely resemble the total economic loss of insured events. Transurance may be substituted for ambiguous policy wording in traditional insurance, so as to eliminate coverage disputes.

For the insurer, transurance represents an opportunity to write more insurance with less transaction costs, since the underwriting effort is minimal and claims adjustment expenses are all but eliminated. Transparency, liquidity, and accessibility are the features transurance wants to achieve for relatively opaque collateral losses. Neither the regulators nor the general insurance companies in India have come to realise the force of transurance, which the developed world is experiencing. It is certain that more resourceful general reinsurers will soon spot robust business sense in transurance.

To transure collateral losses, a company must create a relationship between the amount of collateral losses and the size of the insurance recovery it is likely to receive. For example, if a company believes it will have uninsurable collateral losses equal to 20% of the amount it recovers from its insurance policy, it can purchase a transurance policy that pays 20% of the amount that its insurance policy pays to create a budget for collateral losses.

Transurance enables the insured and the insurer to agree in advance how large the collateral losses will be. By predefining this relationship, business continuity costs that are coincident to insured losses, but aren’t covered by traditional insurance because they are too difficult to define or substantiate can now be insured.

Parametric insurance and transurance are complementary. Transurance usage is likely to step out of property and casualty insurance to all areas of insurance, reinsurance and even life insurance and annuity insurance.

The writer is director, National Insurance Academy, Pune