The year 2023 was the warmest on record, and natural disasters caused an estimated $280 billion in losses, with only $100 billion insured. The insurance coverage gap is particularly pronounced between developed and developing economies. As extreme weather events increase, the insurance industry must find new ways to enhance disaster resilience.
Traditionally, disaster risk reduction relies on indemnity-based insurance products that require physical damage assessment for payouts. This approach, however, proves challenging in the face of widespread devastation, especially for economically disadvantaged communities with limited documentation of their assets.
Parametric insurance offers an alternative solution by triggering payments based on real-time weather measurements. For instance, a policy might pay out if rainfall exceeds 100 mm per day for two consecutive days or if flood levels reach a specific threshold. These products eliminate the need for physical verification, making them particularly effective in disaster-stricken areas.
Island nations facing significant climate risks have embraced parametric insurance, leading to increased trust between governments and insurers and more favorable pricing. While insurers have previously focused on low-frequency, high-impact disasters like earthquakes and cyclones, climate change is driving the adoption of parametric products for high-frequency, low-impact events such as landslides, heavy rain, and heatwaves.
India is a prime example of this shift. The country has successfully implemented parametric crop insurance programs based on pre-defined thresholds, eliminating the need for extensive field verification. Private insurers are expanding the use of parametric products across various sectors, including agriculture, dairy farming, and even worker compensation for heat-related losses.
Governments play a critical role in promoting effective use of parametric insurance. Key factors include establishing precise thresholds, implementing transparent bidding processes for price discovery, facilitating widespread payout systems, and encouraging long-term premium payments by households. India’s Aadhaar-based payment system positions the country well for widespread adoption of these products.
Regional pooling of risk, as demonstrated by the Pacific and Caribbean Catastrophe Risk Insurance Companies, can enhance the effectiveness of parametric insurance. Given South Asia’s vulnerability to climate change, collaborative efforts between India and its neighbors could lead to better deals with global insurance companies.
Parametric insurance offers a promising solution for managing climate risks. As the world grapples with intensifying climate change, embracing this innovative approach could be crucial for protecting lives, livelihoods, and economies.
