How a parametric index is built.

1. Event trigger

The trigger is the physical or market variable being measured. It must be objective, observable, and measurable to a documented precision. Common triggers include wind speed, cumulative rainfall, ground motion (peak ground acceleration), temperature, river gauge level, fire radiative power, and industry loss totals.

The trigger is what the contract pays on — not the policyholder's loss. Selecting a trigger that correlates well with the underlying exposure is a core design decision.

2. Threshold

The threshold is the value at which the index begins to pay out — the attachment point — and, where applicable, the value at which the payout is fully exhausted. Thresholds may be a single point (binary trigger) or a range (linear or stepped trigger).

3. Data source

The data source is the authoritative measurement feed used to settle the index. The source is named explicitly — for example, a specific satellite product, a reference weather station, an exchange index, or a government agency report — and a fallback hierarchy is defined in case the primary source is unavailable.

• Satellite — gridded products for precipitation, sea surface temperature, fire detection, vegetation indices.
• Ground stations — meteorological networks, river gauges, seismometers, air-quality monitors.
• Public agencies — national weather services, geological surveys, statistical offices.
• Market & industry — exchange settlements, modeled industry-loss services, broker indices.

4. Measurement period

The measurement period defines the window over which the trigger value is computed. It can be event-based (the duration of a named storm), seasonal (e.g., the growing season), or fixed-calendar (e.g., July 1 to September 30). Period boundaries — including how the start and end are confirmed — are part of the index definition.

5. Geographic scope

Geographic scope defines where the trigger is measured. Scope can be a single point (a named station), a polygon (an administrative area or a custom geography), a grid cell, or a "cat-in-a-box" region defined by latitude/longitude bounds.

For multi-point definitions, the index also specifies how observations across points are aggregated — for example, the maximum of stations within the polygon, an area-weighted mean, or a worst-of-N rule.

6. Payout curve

The payout curve maps trigger values to payout amounts. Three families are common:

7. Basis risk

Basis risk is the gap between the index payout and the policyholder's actual economic loss. Because parametric contracts pay on a measured variable rather than on indemnity, the trigger may fire when there is no loss (false positive) or fail to fire when there is one (false negative).

Basis risk is reduced by:

• Choosing a trigger that is physically tied to the loss-causing mechanism.
• Tightening the geographic scope so observations sit close to the exposed assets.
• Combining multiple triggers (e.g., wind speed AND surge height) in a layered structure.
• Calibrating the payout curve against historical loss data where available.

Basis risk cannot be eliminated. The framework's role is to make it explicit and quantifiable, not to hide it.

8. Verification and auditability

Every settled value should be reproducible from the published definition. That means:

• The data source is named and versioned, with the exact product, frequency, and revision policy disclosed.
• The aggregation rule (point, polygon, grid, station list) is documented and stable for the contract term.
• Observations used at settlement are archived, with revision history retained.
• An independent calculation agent or audit role can recompute the trigger value from raw observations.

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Index disclosure template

A complete index definition discloses, at minimum, the following fields. Sample values shown for a hurricane wind index.