Parametric insurance: The quick and transparent alternative to traditional cover

Unlike traditional insurance, parametric insurance does not involve risk assessment or loss evaluation. Instead, it relies on trigger points. The insurance company and the insured agree on a parametric index, assuming that when an event is of a certain magnitude, there is a high likelihood of financial loss for the insured. If such an event occurs, the insurer makes the payout as outlined in the contract. This approach enhances transparency, accelerates claim payments, and provides immediate financial relief to the insured.

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Let’s understand this with the example of the Indian government’s Weather Based Crop Insurance Scheme (WBCIS), which harnesses parametric insurance. The scheme aims to protect farmers from financial losses caused by extreme weather conditions related to rainfall, temperature, wind, humidity and so on. Suppose the index for heavy rainfall is set at 12 mm per hour. When rainfall in the insured area exceeds this threshold, the payout is triggered. 

Another example is extreme heat income insurance, which aims to protect underserved communities from income loss due to harsh weather conditions such as heat waves. When heat waves intensify to the level of the parametric trigger, workers are paid their daily wage without having to work on that day. This not only protects them from income loss but from harsh working conditions as well. This insurance solution has taken shape in Gujarat to support women workers in the unorganised sector.

Where else can parametric insurance be used?

Although parametric insurance is predominantly used in weather-related and natural calamity scenarios, it is not limited to these. It can also cover financial stress due to non-asset loss business interruptions, yield disruptions, excess or lack of solar and wind for green energy, cyber disruptions, and other measurable events. 

The renewable energy sector, which is expected to grow significantly in the coming years, often relies on sunlight and wind as primary energy sources. Expected solar irradiance for a given period can be assessed using historical data. Occasionally, unexpected shortfalls in solar energy production may occur, because of anything from cloud movements to atmospheric attenuation. 

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The economic value for this shortfall can be compensated for when it exceeds a parametric threshold. Such coverage helps instil confidence in private investors, encouraging further investment in renewable energy and supporting environmentally friendly initiatives.

It can also be used to cover a reduction in customer footfall for traders due to curfews imposed by authorities. When the footfall drops below average, pre-agreed payouts are triggered.

Parametric insurance offers a unique and innovative approach to risk management. By eliminating the need for traditional loss adjustment, it provides a more efficient and transparent solution for businesses that face a variety of risks. The predetermined payout structure and reliance on objective trigger points ensure swift financial relief, enabling policyholders to recover quickly from adverse events. 

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As technology continues to advance, we can expect parametric insurance to expand into new areas of risk, offering businesses greater flexibility and protection. With its potential to mitigate financial losses and foster resilience, parametric insurance is poised to become an increasingly valuable tool in the modern business landscape.

The author is chief technical officer at Bajaj Allianz General Insurance.