Speedy Payouts, Disaster Relief: How Parametric Insurance Changes Traditional Insurance Landscape?

In India, some of the most common use cases for parametric insurance are those related to natural calamities and certain weather conditions.
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Parametric insurance is increasingly gaining global prominence as a popular alternative to traditional insurance covers. Unlike traditional insurance which requires a detailed examination of losses, parametric insurance works on predetermined, objective parameters to assess payouts in the event of a pre-defined specific triggering event like a cyclone, flood, etc. This type of insurance paves the way for quicker disbursements and is immensely useful in areas most vulnerable to natural calamities. Globally, the Indian government was one of the first administrations to account for parametric coverages to help the agriculture sector. Parametric data from local weather stations is used to insure 35 crops across 17 states.

In India, some of the most common use cases for parametric insurance are those related to natural calamities and certain weather conditions.

How does Parametric Insurance work?

Unlike traditional policies, under parametric insurance claims are settled upon the occurrence of a trigger event. Parametric insurance pay-outs are not based on individual loss adjustments but are determined according to the measurement of event intensities highly correlated to the ‘to be expected loss’. Therefore, there is a possibility of a potential mismatch between parametric insurance claims settlement and the actual losses of the insured.

Also read: 5 Must-Have Insurance Covers For Natural Disasters: Protecting Your Finances In Uncertain Times

The process of parametric insurance goes as follows:

Defining Parameter: The insurance here is agreed upon specific parameters (for example 100 mm of rainfall in 24 hours, a certain level of flood-high, extreme precipitation, etc.).

Trigger Event: If the pre-defined parameter has been met or exceeded, the insurance is triggered.

Payout: The insurer will pay the pre-agreed sum promptly to the insured, bypassing lengthy claims assessments.

Case of Nagaland’s Parametric Insurance

Nagaland is the first state in India to have entered an agreement based on the principles of parametric insurance. The Nagaland State Disaster Management Authority (NSDMA) in coordination with the government proactively engaged with an Insurance company and a Reinsurance company to design parametric coverage for excess rainfall events that can trigger severe flooding. Tata AIG and Swiss Re signed a Memorandum of Understanding with the Nagaland State Disaster Management Authority (NSDMA) in May 2020, to provide insurance protection for that year's monsoon season (May to September).

As per an official circular dated 19th February 2024, the Nagaland government took note of the development of this insurance scheme, which covered rainfall events occurring in 2021, 2022, and 2023 wherein it was financially supported by the Insu Resilience Solutions Fund (ISF). 

With this, Nagaland became a first-time buyer of climate risk insurance and has been since encouraged by the positive experience of implementing the ISF project. This year the government has decided to continue purchasing insurance at the sub-sovereign level even after the completion of the project.

Advantages of Parametric Insurance:

  • It can enable faster recovery from natural hazards by providing necessary financial resources.

  • It can create management capacities to allow immediate emergency response.

  • It can better protect the population and critical infrastructure from extreme weather events and their underlying consequences

Way forward

As climate change worsens, the frequency of natural calamities is expected to rise. Conditions like extreme heatwaves, recurrent floods, dry spells, cyclonic disasters, etc. pose unforeseen risks to human life and state infrastructure.

In such a scenario, parametric insurance can play a significant role in:

  • Strengthening climate resilience

  • Timely insurance payouts to affected individuals and businesses

  • Providing insurance against risks that are typically excluded from traditional insurance policies

Challenges of parametric insurance:

Despite its many benefits like quick disbursement of funds post-disaster, immediate relief, and quicker recovery measures for the populace, parametric insurance comes with certain drawbacks such as:

Accuracy: The issue of ‘data accuracy’ wherein reliable and accurate data is at the core of ensuring this insurance. In case there is a data mismatch the whole policy may fall out and may hinder fair payouts.

Acceptance: Educating stakeholders regarding the benefits and mechanisms of parametric insurance still remains a challenge given its complex definition of scrutiny of pre-defined cover areas.

Regulation: Building a comprehensive regulatory framework to understand and establish the nuances of parametric insurance is still an ongoing process where its wide-scale implementation needs more case studies.

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