What is parametric insurance?
Fundamentally, parametric (or index based) solutions are a type of insurance that covers the probability (or likelihood) of a loss-causing event happening (like an earthquake) instead of indemnifying the actual loss incurred from the event.
It is an agreement to make a payment upon the occurrence of a covered event meeting or exceeding a predefined intensity threshold, as measured by an objective value (or parameter – hence the name 'parametric insurance')
The covered events could be earthquakes, tropical cyclones, or floods where the parameter or index is the magnitude, wind speed or water depth respectively.
Need for alternative insurance methods to address the financial impact of natural disasters
A report estimated that losses from natural disasters amounted to $280 billion in 2023, of which only about $100 billion was insured.
The gap in insurance coverage was particularly wide between developed and developing economies
With the world experiencing a surge in extreme weather events, the insurance industry needs to enhance disaster resilience by devising a number of alternative methods of coverage.
In this context, several insurance products based on the parameters of a weather event are needed
In these, payments are triggered based on real-time measurements such as rain of more than 100 mm per day for two days in succession, or specific flood levels, and wind speed.
For such ‘parametric’ products, payments are made regardless of actual loss or physical verification.
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
In India, one of the earliest uses of parametric policies was crop insurance, initiated by the government some years ago.
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
For governments to ensure effective use of parametric products, 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; and
encouraging premium payment by households in the long term.
COMMENTS