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Parametric insurance has the potential to transform crop insurance

By Aditya Singh, Senior Treaty Broker, New Dawn Risk Group

Agriculture is still the most important sector in many developing economies and is directly affected by climatic shocks, which have the potential to threaten global food security and stability, cripple livelihoods, disrupt value chains, and even undermine macroeconomic stability.

Climate change and the increased prevalence of extreme weather events are causing increasing damage to crops and agricultural land. A study from Stanford researchers found that higher temperatures attributed to climate change caused payouts from the nation’s biggest farm support program to increase by a staggering $27 billion between 1991 and 2017. Costs are likely to rise even further with the growing intensity and frequency of heat waves and other natural catastrophes.

Last year, analysts at KBW warned that crop losses will likely weigh on insurers’ overall underwriting profits for 2021, despite being overshadowed by more high-profile catastrophe losses such as Hurricane Ida and the European floods.

However, there is a way forward that can benefit both farmers and insurers.

The rise of parametrics

The use of parametric structures will be familiar to participants in the insurance-linked securities market, as the mechanisms that trigger catastrophe bonds to make reinsurance pay-outs to carriers when losses from a natural catastrophe (nat cat) event exceed insured limits.

The use of parametric triggers is also finding favour in the insurance market as well, with a growing number of applications for parametric insurance promising to fill the gaps that traditional indemnity products have failed to address. 

The need for risk financing solutions in countries with low insurance penetration has long been recognised as a critical area of focus for the industry, particularly for funding recovery efforts following a catastrophe.

To date, efforts have focused on government-backed risk pooling schemes, such as the Caribbean Catastrophe Risk Insurance Facility, which pays out to selected governments in the region following major nat cat loss events such as hurricanes and earthquakes.

However, there is also a growing case for the deployment of parametric insurance coverage in underdeveloped countries to facilitate payments to individual policyholders following loss events. With climate change driving incidents across a range of perils – flood, drought, wildfires, etc – farmers, small business owners, and householders around the world increasingly need workable insurance solutions that pay out quickly following a claim.

The technology now exists to enable real-time reporting of a number of perils, using accurate, reliable and often freely-available data. As such, it has been possible to place parametric insurance coverage across a wide spectrum of risk types, including earthquake, hurricane, drought and flooding.

The parametric triggers for this coverage can be structured using a variety of measurable factors, such as shake density for quake, wind speed for hurricane, water depth and rainfall for flood, and factors such as rainfall (or the lack of) and crop health for certain agricultural risks.

The case for parametric insurance

While regulations vary between countries on how quickly insurers should respond to insurance claims, anecdotal evidence suggests many claims take more than 30 days to be settled. This naturally leads to policyholders becoming frustrated with the process, and speed of claims acknowledgement and settlement is therefore a key factor for insureds when looking to buy any type of insurance.

In the case of traditional indemnity insurance, claims are handled by assessing damages after the fact, which means disputes can arise between the policyholder and carrier over the scope of coverage. In addition, the carrier, in many cases, may end up paying out less than the policyholder was expecting, leading to further disputes, or more than they had reserved for, pushing up the carrier’s loss ratio.

By using predetermined metrics that have been mutually agreed by insurer and insureds, carriers can leverage loss data to immediately verify claims against parametric coverage, quickly adjust them and then pay out a pre-agreed amount without the need for any disputes or further processing.

Speedier capital deployment following a loss event helps individuals and communities recover from natural disasters faster. And the predetermined triggers also give a specific pay-out guarantee, ensuring carriers don’t pay out more than necessary, while giving policyholders a settlement that is in line with their expectations.

The scope of parametric solutions

Parametric solutions also allow for the coverage of risks that have traditionally been excluded from traditional claims processes, but which have a measurable objective parameter – such as demand surge during reconstruction, food spoilage and crop yields. 

One real-world example of where parametric insurance could introduce greater efficiency into the claims process, and ultimately deliver solutions in previously under-served markets, is in the Indian agricultural sector – specifically, insuring against fluctuations in crop yields.

India has had a government-sponsored agricultural insurance programme for over thirty-five years, giving pay-outs to small farmers whose crops have failed. The programme has been criticised in the past for both the timeliness of payments and the inefficiency of its administration.

The introduction of a range of new technologies, including a mobile portal for reporting loss data, the use of satellite and drone imaging technologies for remote sensing of crop damage, and analytics based on data from a variety of weather indices, are being used to drive claims automation and, ultimately, make the scheme more profitable and therefore attractive to re/insurers.

With weather-related catastrophes continuing to take a heavy toll on communities across the globe, the use of clearly-defined triggers for insurance coverage can help to deliver more precise, streamlined insurance pay-outs, enabling communities to start rebuilding sooner, and empowering carriers to offer more comprehensive coverage.

This is changing the game for insurance carriers around the world – and is transforming the way they interact with previously under-served markets.