Parametric Insurance: Can it provide the financial safety net India needs against climate risks?

Between 2000 and 2019, India experienced the third-highest number of natural disaster events globally. The future looks grim as the frequency and intensity of these disasters are projected to increase, causing losses and damages running into billions of U.S. dollars. Traditional government funds may not be enough to cover these costs, highlighting the need for innovative financial solutions.

One such novel tool India is cautiously experimenting with is parametric insurance. Unlike conventional insurance schemes, which rely on indemnity and post-disaster loss evaluations, parametric insurance operates on predefined parameters that, when met, trigger immediate payouts. This approach is particularly crucial in a country like India, which experiences natural disasters quite frequently.

According to a report by the Centre for Science and Environment, India encountered weather-related disasters almost daily in the first nine months of 2022 alone. Between 2019 and 2023, these disasters led to damages worth $56 billion.

The mechanics of parametric insurance

Parametric insurance differs fundamentally from traditional insurance. It utilizes predetermined metrics, such as rainfall levels or wind speeds, to trigger payouts. This system eliminates the need for individual loss assessments, allowing for quicker disbursement of funds.

For example, a parametric insurance policy for floods caused by heavy monsoon rainfall might be structured around cumulative rainfall data. If the total accumulated rainfall in a region exceeds a specific threshold within a set timeframe, the insured parties receive compensation.

Consider a scenario in a location where workers are insured under a parametric policy. If total accumulated rainfall for a specified duration exceeds a certain threshold, the workers are eligible for financial assistance. The compensation increases with the level of rainfall upto a defined limit. This structure ensures that workers receive timely financial support without the need for damage assessment.

The importance of parametric insurance

India's disaster management funds typically come from the National or State Disaster Response Fund (SDRF) and international aid. The National Disaster Management Authority (NDMA) contributes between 75% to 90% of the funds from the central government, with the rest supplied by state governments. However, these funds are not always immediately available. International aid, while beneficial, is unpredictable and complicates comprehensive risk management.

Parametric insurance, by contrast, provides a reliable and prompt financial response to disasters. It allows governments to assess potential damages in advance and ensures financial liquidity, facilitating faster rehabilitation and restoration efforts. This is particularly vital in a country like India, where the economic impact of natural disasters is significant and immediate support can make a substantial difference.

Preventive care data-driven decision making

The success of parametric insurance hinges on accurate data and sophisticated calculations. Insurers must estimate the magnitude and frequency of hazards over time and relate these to potential damages. This data-driven approach helps determine the thresholds for payouts and the cost of insurance premiums. Reliable and precise data from sources like the Indian Meteorological Department (IMD) is critical for setting these parameters.

At the end of the coverage period, for instance, daily rainfall data from the IMD would be analyzed to calculate cumulative rainfall. If the predetermined thresholds are met, the corresponding compensation is disbursed as per the policy terms. This method ensures transparency and efficiency in the payout process, reducing delays and administrative burdens.

The future of parametric insurance in India

As India continues to face the increasing threat of natural disasters, parametric insurance offers a promising solution to bridge the finance gap in disaster management. It complements existing funding mechanisms by providing a rapid and reliable source of financial support. Moreover, it promotes a proactive approach to risk management, encouraging governments and businesses to plan for potential disasters rather than react to them.

The success of parametric insurance in India will depend on several factors, including the availability of accurate data, the willingness of stakeholders to adopt this new model, and the development of affordable and accessible insurance products. As awareness of the benefits of parametric insurance grows, it is likely to become an integral part of India's disaster resilience strategy.

Parametric insurance represents a significant step forward in disaster risk management for India. By providing immediate financial relief based on predefined parameters, it ensures that support reaches those in need without delay.

As climate change continues to exacerbate the frequency and intensity of natural disasters, innovative solutions like parametric insurance will be crucial in safeguarding communities and ensuring sustainable development. With continued investment in data infrastructure and stakeholder engagement, parametric insurance can help India build a more resilient future.

Deepak Kumar, Senior Executive Vice President and Head, Reinsurance, Credit and Aviation Insurance, TATA AIG General Insurance