Parametric insurance: Can it provide the financial safety net India needs in the face of climate risks?

Between 2000 and 2019, India was the third nation with the highest number of natural disasters in the world. The future looks bleak as the frequency and intensity of these disasters are projected to increase, causing billions of US dollars in losses and damages. Traditional government funds may not be sufficient to cover these costs, highlighting the need for innovative financial solutions.

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

According to a report by the Centre for Science and Environment, in the first nine months of 2022 alone, India suffered from climate-related disasters on an almost daily basis. Between 2019 and 2023, these disasters caused damages worth $56 billion.

The mechanics of parametric insurance

Parametric sure It differs fundamentally from traditional insurance. It uses predetermined parameters, such as rainfall levels or wind speed, to trigger payouts. This system eliminates the need for individual loss assessments, allowing for faster disbursement of funds.

For example, a parametric insurance policy against flooding caused by heavy monsoon rains could be structured around cumulative rainfall data. If the total cumulative rainfall in a region exceeds a specific threshold within a given time period, the insured parties receive compensation.

Let us consider a scenario in a place where workers are insured under a parametric policy. If the cumulative total rain If the duration of the drought exceeds a certain threshold, workers are entitled to financial assistance. The compensation increases with the level of precipitation up to a defined limit. This structure ensures that workers receive financial assistance in time without the need for a damage assessment.

The importance of parametric insurance

India’s disaster management funding typically comes from the National or State Disaster Response Fund (SDRF) and international aid. The National Disaster Management Authority (NDMA) provides 75-90% of central government funding, with the remainder provided by state governments. However, these funds are not always immediately available. International aid, while beneficial, is unpredictable and complicates comprehensive risk management.

Parametric insurance, on the other hand, offers a fast and reliable financial response to disasters. It enables governments to assess potential damage in advance and ensures financial liquidity, facilitating faster rehabilitation and restoration efforts. This is especially vital in a country like India, where the economic impact of natural disasters is significant and immediate support can make a substantial difference.

Data-driven decision making in preventive care

The success of parametric insurance depends on accurate data and sophisticated calculations. Insurers must estimate the magnitude and frequency of risks over time and relate them to potential losses. This data-driven approach helps determine payout thresholds and the cost of insurance premiums. Reliable and accurate data from sources such as the Indian Meteorological Department (IMD) is critical to establishing these parameters.

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

The future of parametric insurance in India

As India continues to face the growing threat of natural disasters, parametric insurance offers a promising solution to bridge the financing gap in disaster management. It complements existing financing mechanisms by providing a quick and reliable source of financial support. It also promotes a proactive approach to risk management, encouraging governments and businesses to prepare 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 embrace this new model, and the development of affordable and accessible insurance products. As awareness about the benefits of parametric insurance increases, it is likely to become an integral part of India’s disaster resilience strategy.

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

As climate change continues to exacerbate the frequency and intensity of natural disasters, innovative solutions such as parametric insurance will be crucial to protecting communities and ensuring sustainable development. investment In terms of 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