The rise of Parametric Insurance – Transforming the Insurance landscape

As per statistics available from the Insurance Information Institute, the total global losses from natural disasters averaged around US$200 billion over the past decade of which the insured losses averaged at around $83 billion. The year 2023 was the warmest year on record and the estimated losses from natural disasters amounted to US$280 billion. Out of this only about US$100 billion were insured losses. The gap in insurance coverage was particularly wide between developed and developing economies. Due to climate change, the world is witnessing a surge in extreme weather events and therefore the insurance industry needs to come out with alternative & innovative insurance covers.

Parametric insurance has been gaining traction worldwide due to its innovative approach to addressing specific risks with transparent and predictable payouts. This insurance segment is witnessing significant growth due to its ability to offer quicker payouts based on objective triggers, reducing the time and complexity associated with traditional insurance claims processing and settlements. The evolution of data analytics, advancements in technology, and increasing awareness of risk management strategies are further driving the expansion of parametric insurance globally.

Parametric insurance in India is gradually gaining attention and adoption, particularly in sectors vulnerable to natural disasters and weather-related risks. India is prone to various natural disasters such as floods, cyclones, earthquakes, and droughts, which often cause significant economic and social impacts. Traditional insurance products may not adequately cover these risks due to challenges in assessing and indemnifying losses.

Parametric insurance pays out a predetermined amount upon the occurrence of a predefined event, based on objective data such as weather conditions, seismic activity, or economic indicators. This contrasts with traditional insurance that indemnifies actual losses. Since the payouts are triggered by data rather than claims assessment, parametric insurance offers rapid compensation, crucial for disaster recovery or business continuity. In Parametric insurance covers, a well-defined trigger and payout structure reduces ambiguity and potential disputes. Policies can be tailored to specific risks, allowing coverage for events traditionally difficult to insure. Parametric insurance can cover damages caused by floods, cyclones, earthquakes, hurricanes, etc. using meteorological data. Companies insure against revenue loss due to specific events impacting their operations/supply chain resulting in Business Interruption. ?

In India, Parametric insurance is being used to protect farmers against weather-related risks that affect crop yields, such as excessive rainfall or drought. Governments and businesses are exploring parametric solutions to cover losses from natural disasters, ensuring quick access to funds for recovery efforts. Weather-Based Crop Insurance Scheme (WBCIS) Introduced by the Government of India is a parametric insurance scheme that covers losses due to adverse weather conditions impacting crops and farmers. It uses historical weather data and predefined triggers to determine payouts.

Parametric insurance in India is also popular in the renewable energy sector. Particularly well-suited for solar and wind power companies due to the inherent variability and dependence on specific weather conditions for energy production. Parametric Insurance for Solar Power Companies can be designed mainly to cover losses as a result of Solar Irradiance, Cloud Cover and temperature extremes. Similarly, the Parametric Insurance for Wind Power Companies can be designed to cover losses due to Wind Speed, Wind Direction, and Storm Events. Thus the Parametric insurance offers solar and wind power companies a robust mechanism to manage the financial risks associated with variable weather conditions.

Parametric insurance can also support infrastructure projects by providing financial protection against delays caused by weather disruptions. There are discussions and initiatives to establish parametric Natural Disaster insurance pools or mechanisms at the national or regional level to cover catastrophic events like earthquakes and floods. Some non-profits and micro-finance institutions have also worked with private insurers to implement daily payouts to workers who lose wages due to excessive heat, based on pre-defined temperature and moisture triggers.

The first Indian state to buy a Parametric Insurance cover is Nagaland. It was the first Indian State to buy a parametric cover for extreme precipitation in 2021. In the subsequent years, the coverage under the policy was broadened based on exposures and other learnings. For the trigger, it has used the India Meteorological Department’s data on precipitation for various tehsils. This is opening the doors for other States to consider similar Parametric insurance products for insurance against Rain, Cyclones, wind, etc.

Few FMCG Cos have bought parametric insurance to cover the financial loss suffered due to inadequate rainfall in the areas from where they procure their raw materials which are typically agricultural products (fruits/ vegetables/ food grains). 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. Parametric insurance for event cancellation due to adverse weather, natural disasters, or other predefined conditions is also growing. It ensures organizers can recoup losses quickly if events cannot proceed as planned.

In India, a few insurers such as ICICI Lombard, HDFC Ergo, Tata AIG, and Chola MS, and Global reinsurance firms such as Swiss RE & Munich RE offer parametric insurance solutions. Many other insurance cos. are in the process of launching these insurance products in the near future. For insurers, the availability of reliable and accurate data on weather patterns and historical events is crucial for designing an effective parametric insurance cover. Advances in data analytics, satellite technology, and IoT have enhanced the accuracy and scope of parametric insurance, enabling real-time monitoring and quicker response.

Thus Parametric insurance solutions continue to evolve as a modern and important tool in risk management. The growth of this class of insurance is driven by technological advancements, increasing risk awareness and the need for resilient financial solutions in a volatile world. Parametric insurance in India holds promise as a critical tool for managing weather-related and natural disaster risks, offering faster, more predictable financial protection to businesses and public entities. While parametric insurance is experiencing robust growth globally due to its efficiency and responsiveness in risk management, its adoption in India is gradually increasing, especially in sectors vulnerable to weather-related risks. Also, there is a need to educate stakeholders about the benefits and limitations of parametric insurance to increase adoption. With supportive policies and technological advancements, the future looks promising for parametric insurance both globally and in India.