Parametric insurance, also known as index-based insurance, is a type of coverage in which the insurance company and the customer agree on an amount that will be paid if a specific event occurs. The event must be measurable and in order to make the payout, its intensity must meet or exceed a pre-agreed parameter or index, such as wind speed, rainfall or earthquake strength.
Unlike traditional insurance, parametric insurance does not include risk assessment or loss evaluation. Instead, it relies on trigger points. The insurance company and the insured agree on a parametric index based on the assumption that when an event reaches a certain magnitude, there is a high probability of financial loss for the insured. If such an event occurs, the insurer will pay out as described in the contract. This approach increases transparency, accelerates the payment of claims and provides immediate financial assistance to the insured.
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Let us understand this using the example of the Government of India’s Weather Based Crop Insurance Scheme (WBCIS), which uses parametric insurance. The scheme aims to protect farmers from financial losses caused by extreme weather events related to rainfall, temperature, wind, humidity and so on. Suppose the heavy rainfall index is set at 12 mm per hour. When rainfall in the insured area exceeds this threshold, the payout is activated.
Another example is extreme heat income insurance, which aims to protect disadvantaged communities against loss of income 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 wages without having to work on that day. This not only protects them against loss of income, but also against harsh working conditions. This insurance solution has taken shape in Gujarat to support women workers in the unorganized sector.
Where else can parametric insurance be used?
Although parametric insurance is mainly used in scenarios involving weather conditions and natural disasters, this insurance is not limited to that. It can also cover financial stress due to business interruptions without asset loss, revenue disruptions, excess or lack of solar and wind energy 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. The expected solar radiation for a certain period can be assessed using historical data. Occasionally, unexpected shortfalls in solar energy production can occur, due to everything from cloud movements to atmospheric weakening.
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The economic value of this deficit can be compensated when it exceeds a parameter threshold. Such coverage helps build confidence among private investors, encourages further investments in renewable energy and supports environmentally friendly initiatives.
It can also be used to cover a reduction in the number of visitors to traders due to curfews imposed by the authorities. When the number of visitors falls below average, pre-agreed payouts are activated.
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 facing a variety of risks. The predetermined payout structure and reliance on objective trigger points provide quick financial relief, allowing policyholders to recover quickly from adverse events.
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As technology continues to develop, we can expect parametric insurance to expand into new risk areas, giving businesses more flexibility and protection. With its potential to reduce financial losses and promote resilience, parametric insurance is poised to become an increasingly valuable tool in the modern business landscape.
The author is a Technical Director at Bajaj Allianz General Insurance.
