The Promise Of Parametric Insurance

With the world experiencing a surge in extreme weather events, the insurance industry needs to enhance disaster resilience by parametric insurance coverage. 

About Parametric Insurance Coverage

• Real-time Measurement: Several insurance products based on the parameters of a weather event are needed, wherein, payments are triggered based on real-time measurements such as specific flood levels, wind speed, etc. 
  • For such ‘parametric’ products, payments are made regardless of actual loss or physical verification. 
• Provisions Offered: Thus far, insurers have been offering standardized parametric products only for low frequency, high-impact disasters such as earthquakes, cyclones, and hurricanes. 
  • In 2023, after a 6.8 magnitude earthquake struck Morocco, it received $275 million parametric insurance cover arranged with the help of the World Bank. 
  • High frequency but low-impact disasters such as landslides, rain, and heat were overlooked, but the consequences of climate change are slowly changing that.
• Followed by: Disaster-prone island countries have largely shifted from the risk retention model and embraced such insurance for climate adaptation. 
  • Over time, this has built trust between states and insurers, leading to more reasonable pricing and trigger-payout combinations.
  • While this is more difficult in poorer populations, parametric insurance for earthquakes in New Zealand and Turkey has shown that it can be done.
  • Aided by multilateral institutions, the Pacific and Caribbean Catastrophe Risk Insurance Companies have displayed regional pooling of risk and have successfully implemented parametric contracts with the insurance sector. 

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Parametric Insurance Coverage in India

• Crop Insurance: The successful Pradhan Mantri Fasal Bima Yojana is based on verification of loss, while a new parametric product, the Restructured Weather Based Crop Insurance Scheme is based on threshold limits, not requiring field verification.
• Role of States: 
  • Nagaland: The first State to buy a parametric cover for extreme precipitation in 2021. 
    • It fixes an absolute annual premium, duration and rate-on-line, allowing bidders to compete over lower threshold limits and maximized payouts. 
    • It has imaginatively used the India Meteorological Department’s credible supply of data on precipitation for tehsil-sized grids, opening the doors for other States to consider similar products for insurance against cyclones, wind, and rain.
  • Kerala: The Co-operative Milk Marketing Federation in Kerala too has implemented parametric insurance for dairy farmers for lower milk yields due to heat stress to cattle.
• Contribution by the Private Insurance Industries: They have witnessed a rising number of offers of parametric products, customized for States, corporations, self-help groups, and micro-finance institutions. 
  • They insure disasters such as extreme precipitation, which is an endemic issue in the north-east; cyclones, which are a standard occurrence in coastal States and extreme heat, a suddenly prominent and much-publicized hazard.
• Contribution by Corporations: Some large corporates have initiated parametric products for cyclonic winds and high waves at competitive prices, using wind speed, cyclone tracks, and storm surge data.
• Need: The recent impact of heavy rains in West Bengal, Meghalaya, Manipur, and Mizoram in the aftermath of Cyclone Remal underscores the need to reduce the financial burden of the State.

Arising Concerns

• Gap in Insurance Coverage: As per a recent report, losses from natural disasters amounted to $280 billion in 2023 (warmest year on record), of which only about $100 billion was insured. 
  • The gap in insurance coverage was particularly wide between developed and developing economies. 
• Difficult for Assessment: At present, the globally accepted method of disaster risk reduction is to transfer risk through indemnity-based insurance products, which require physical assessment of damage for payouts. 
  • However, calamities that hit large populations and wipe out settlements, especially of the economically disadvantaged communities who have little record of their assets, it becomes difficult to verify the losses.

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Way Forward

• Ensure Effective Use: For governments to ensure effective use of parametric products, following five factors are essential: 
  • Precise thresholds and proper monitoring mechanisms
  • Experience sharing between governments to incorporate lessons learned
  • Following the mandatory bidding process for transparent price discovery
  • A widespread retail payout dissemination system
  • Encouraging premium payment by households in the long term
• Collaborative Approach: Given South Asia’s reputation as the world’s most “climate-vulnerable zone”, India and its neighborhood could consider such products, pool their risks collaboratively, and strike better bargains with the world’s largest insurance companies.
  • India is uniquely placed for the use of such products, given that it has the Aadhaar-based payment dissemination system.