Parametric/Index Based Insurance in Chile: From Theory to Regulatory Practice

Alessandri - Parametric (or index based) insurance represents a novel approach in insurance in Chile. It is activated automatically and is based on the verifiable occurrence of an event measured by an objective index, eliminating the need for an expert assessment of damages. Unlike traditional insurance, which requires a damage verification process, parametric insurance establishes the payment of a predetermined fixed sum upon the fulfillment of a specific condition, such as exceeding a seismic magnitude or accumulated precipitation threshold. These instruments work by using indices or parameters, which are physical, meteorological, or geographical variables that can be objectively measured, such as ground acceleration, temperature, wind speed, or precipitation levels. The risks that can be covered by this type of insurance are wide ranging, from natural disasters (earthquakes, fires, droughts, floods, storms, volcanic eruptions, storm surges) to interruptions in basic services and loss of profits. The main advantage of parametric insurance is the speed of compensation payments, which provides immediate access to liquidity after a catastrophic event. This feature makes it a crucial tool for reducing protection gaps, especially in sectors that are vulnerable or difficult to insure using conventional methods, such as agriculture, microenterprises, and rural communities.

The CMF has demonstrated a strong commitment to integrating parametric insurance into the Chilean legal system. On June 23 of this year, the CMF published a revised version of the rule (NCG) that regulates this modality. This second iteration of the draft implementing regulations, which incorporates valuable input from the consultation process that began in September 2024, marks a substantial advance in terms of clarity, flexibility, and consumer rights protection. However, regulatory and operational challenges remain and must be given adequate consideration to ensure successful and sustainable implementation.

It is to be noted that this NCG is still in the public consultation stage.

The revised version of the NCG introduces significant improvements that optimize its design and scope.

One of the most notable improvements is the expansion of the catalog of authorized risks and indices. While the scope was initially limited to earthquakes, fires, and certain weather events, it now covers a much wider range, from volcanic eruptions and storm surges to interruptions in basic services, transportation, or loss of profits. It even allows different indices to be combined in the same policy, which improves the accuracy of the design and reduces the dreaded "basis risk." This concept, little known outside the technical world, refers to the possibility of actual damage occurring—for example, a flood affecting a farmer—but the index defined in the policy (such as the amount of rainfall recorded at a nearby weather station) not reaching the threshold required to trigger the insurance payout. In other words, the basis risk is the gap between the reality of the damage and the insurance trigger and is one of the main challenges of this type of product. Another significant advance is the inclusion of insurance brokers in the innovation process. It will no longer be only insurers who can propose new products or indices to the CMF. This openness democratizes innovation and recognizes the key role that intermediaries play in bringing solutions to customers, especially in markets where financial literacy is still low. The structural clarity introduced by the new regulation is also welcome. Policies are required to explicitly state that they are parametric insurance, the use of the term "index" is standardized, and its marketing as an additional clause in other policies is prohibited. The latter is key to avoiding confusion in claims settlement and protecting the insured from unrealistic expectations. In terms of settlement, the payment period is extended from 6 to 15 business days, which responds to legitimate market concern: the data that triggers the insurance is not always available immediately. In addition, a specific technical reserve regime is established for parametric earthquake insurance, requiring 100% of the premium to be retained throughout the term of the contract. This measure seeks to avoid potential solvency problems in the system following the adoption of this new class of insurance.

Despite regulatory progress, the effective implementation of parametric insurance still faces regulatory and operational challenges. One point of debate is the requirement that all new parametric indices or risks must be approved in advance by the CMF. This provision, contained in Article II of the NCG, seeks to ensure technical consistency, but it could become a bottleneck for innovation, especially given the speed with which current technology allows real-time indices to be generated. Although the CMF rejected a proposal for a more flexible approach, citing Article 11 of DFL No. 251, it is possible to explore more agile mechanisms within the legal framework, such as a framework regulation with technical annexes that can be updated by resolution.

For insurance companies, the benefits are clear: they allow them to cover risks that are traditionally difficult to insure, opening the door to greater portfolio diversification. In addition, by eliminating the need for expert appraisals, these products bring lower operating costs and provide immediate liquidity to the insured. Perhaps most importantly, parametric insurance is ideal for historically underserved segments, serving as a tool for financial inclusion. However, its implementation requires internal transformation within insurance companies, requiring technical capacity to model risks and manage expectations regarding "basis risk," which can lead to frustration and compliants if the customer does not understand why the insurance was not activated. Added to this is a growing regulatory burden from the CMF.

In this new scenario, insurance brokers have a strategic opportunity, not only as distributors but also as co-creators of products, and their educational role becomes even more relevant to avoid misunderstandings. This new role requires technical updating in various concepts.

Let us not forget that the marketing of parametric insurance must strictly comply with Article 28 of Law No. 21,521 (Fintech Law), which involves responsibilities for companies and brokers:

• Customer suitability: Entities must implement policies, procedures, and controls to avoid offering insurance that does not meet the needs of customers. To do so, it is essential to collect relevant information about their operations, size, and complexity.
• Explicit warning: In cases where a customer decides to purchase insurance that does not match their needs, expectations, or communicated risks, the company is required to prove to the CMF that the customer was duly warned of this situation prior to purchase.
• Transparency in communication: All information, advertising, or publicity for parametric insurance, in any medium, may not contain statements, allusions, or representations that could be misleading, or cause confusion to the public regarding the nature, prices, or any other characteristic of the product.

The main value of this regulation lies in helping to open the door for the market to offer low-cost complementary coverage, especially in contexts of exposure to catastrophic risks. This model does not seek to replace indemnity insurance, but rather to complement it, providing immediate liquidity for the first few days after a disaster. Naturally, this transformation involves costs: insurance companies will have to invest in the design and technical validation of new products, as well as in the implementation of systems for the collection and periodic submission of information. The CMF, for its part, will have to allocate resources to supervise and manage claims, given the inherent complexity of parametric insurance, which can cause confusion among policyholders. This is where one of the most sensitive risks emerges: market conduct. If the index is not triggered despite damage suffered, the insured may feel cheated, leading to massive claims and a loss of confidence. For this reason, the CMF anticipates the need for financial education to clearly explain how this type of insurance works.

The NCG proposal seeks to gather best practices, establishing clear criteria, requiring actuarial reports, and defining a specific technical reserve regime. It allows for the combination of indices and expands the catalog of insurable risks, opening the door to more sophisticated products. However, its success will depend on the insurance ecosystem’s ability to adapt, educate, and evolve. Transparency in the use of indices and agility in authorizing new products will be the next challenges. The CMF appears to have struck a reasonable balance between regulatory prudence and promoting innovation. This parametric insurance regulation has the potential to be a powerful tool for closing protection gaps in a nation as exposed as Chile. But like any innovation, it requires vigilance, adaptation, and, above all, a deep understanding of its technical, operational, and social implications. Because in the world of insurance, as in life, it is not enough to have a good idea. It must be implemented well, explained better, and adjusted when necessary.

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