Parametric insurance is a simple kind of insurance that pays out based on whether or not a particular event happened, such as a natural disaster. For homeowners, parametric insurance can be a good tool to protect yourself in case of natural disasters — especially if you live in a high-risk area.

How does parametric insurance work?

Unlike most kinds of insurance, which reimburse you for the cost of damage (such as for damage to your home after a windstorm), parametric insurance pays out if a particular event occurs — without considering whether any damage occurred.

For example, if you live in an earthquake-prone area, you could take out a parametric insurance policy that pays out $10,000 if an earthquake over 5.0 on the Richter scale occurs where you live. And if an earthquake that big does occur, you get the money automatically — regardless of whether your home incurs $10,000 of damage, $100,000 or none at all.

Another common type of parametric insurance is life insurance. For those policies, the payout is based on if the person named passes away.

Parametric insurance policies typically have some kind of measurement associated with them. For an earthquake, it'd likely be the strength of the earthquake measured on the Richter scale, as calculated by the United States Geological Survey. For travel delays, it could be a number of hours or days your trip is delayed, as measured by the airline. If the number is hit, you get paid; if not, you don't get anything.

How parametric insurance is different from home insurance

The biggest benefit of a parametric insurance policy over standard homeowners insurance is that you can buy a policy for lots of types of events that might not be covered under a typical homeowners insurance policy, like flooding or volcanic activity. Or, you can use parametric insurance to protect yourself from things that don't pertain to your home at all, like unexpected delays while traveling.

Another benefit of parametric insurance is how quickly claims can be paid out. With a typical homeowners insurance policy, you need to get your home inspected by an adjuster, get estimates from contractors and, in some cases, have the work completed before you'll be fully reimbursed. However, with a parametric policy, you'll be paid as soon as your insurer can verify the event occurred. This means payouts take days or a few weeks, not months.

Parametric insurance vs. homeowners insurance

This is especially useful in widespread disasters, where hundreds or thousands of simultaneous claims can bog down the claims system and lead to months of delays.

Parametric insurance policies also don't have deductibles, exclusions or adjusters to determine the extent of the damage, so the process of making a claim is very simple.

When should I consider parametric insurance?

Parametric insurance is most useful in two situations: when you can't get adequate coverage from another source or when you need your payout to be fast.

When you can't get coverage elsewhere

Homeowners whose properties are at a very high risk of damage from a specific peril sometimes can't get a typical homeowners insurance policy or can only get one that excludes that peril. For example, homeowners in California might not be able to get protected from wildfires, or coastal Florida residents might not be protected from hurricane wind damage.

Other perils aren't covered by any kind of insurance or are only covered under very expensive extra policies. This includes things like volcanoes and earthquakes.

In all of these cases, you would likely be eligible to buy a parametric insurance policy to help protect against losses.

When you need payment fast

If you're concerned about the speed with which you might receive a claim payout, a parametric insurance policy could be beneficial. Suppose you live in an area susceptible to hurricanes, and your roof is damaged by a storm. Even if wind damage is covered by your policy, getting an adjuster to come to inspect your claim and then having your roof fixed may take weeks or months.

On the other hand, if you have a parametric policy that pays out anytime there's a Category 3 or higher storm, you'd be paid soon after the incident occurred.

However, given the extra cost of parametric insurance and the fact that you're likely required to have regular homeowners insurance anyway, it's usually best to have a smaller policy of only a few thousand dollars to act as a stopgap before your regular home insurance goes into effect.

To help meet a high deductible

Some parametric insurance policies work in tandem with your regular homeowners insurance to help you meet your deductible. This is a common use-case for homeowners whose properties are at a high risk of one particular source of damage, like flooding, earthquakes or hurricanes.

For example, you might have a regular deductible on your homeowners insurance policy of $2,000 but a hurricane deductible of $20,000. A parametric insurance policy tied to a hurricane could help you meet that deductible without having to pay it out of pocket.

When not to get a parametric insurance policy

Parametric insurance isn't a catchall replacement for a regular homeowners insurance policy. If you buy parametric insurance, you're only protected against one very specific instance, and only if specific criteria are met.

While regular homeowners insurance protects you against a wide variety of damage sources, each parametric policy only covers one thing. To protect yourself against fire, theft and wind damage, you'd need three separate policies — but all of these perils are covered by a single homeowners policy.

Additionally, any homeowners insurance requirements you have — such as from a homeowners association (HOA), or if your mortgage requires a policy — likely won't be satisfied by parametric insurance.

How do I get parametric insurance?

Since it's a fairly small market compared to regular homeowners insurance, it might not be as easy to get a parametric insurance policy as a typical homeowners policy.

Depending on the type of policy you want to buy, you may need to contact an insurance agent to have them design the policy for you.

However, for some more common types of parametric insurance, you may be able to get a quote online. For example, StormPeace sells online parametric insurance in Florida that pays out if a hurricane happens. To buy a policy, you just need to provide your location and the amount of coverage you'd like to buy.

If you have homeowners insurance coverage that includes hurricane damage, you're only allowed to buy coverage up to your hurricane damage deductible. If you don't have hurricane coverage, you can buy up to $60,000 of coverage.