Indians are trying out a new insurance to deal with the costs of increasing natural disasters

Over two decades, between 2000 and 2019, India faced the third most number of natural disaster events in the world. Future prospects are grim – with the frequency and intensity of many natural disasters projected to increase, losses and damages will run into billions of US dollars. State coffers may not have the funds to pay.

India is cautiously experimenting with a novel tool to help bridge this finance gap: parametric insurance. Unlike regular insurance schemes which are based on indemnity, or an evaluation of losses post a disaster event, parametric insurance relies on a predetermined set of parameters which, when met, triggers a payout immediately. “There is no survey or lengthy assessment period, which is the main point of difference,” said Pankaj Tomar, India head of Axa Climate, a venture of the AXA Group focussed on creating climate adaptation solutions.

Jashiben Parmar, a 60-year-old construction labourer from Ahmedabad’s Ambawadi municipality, said she could make up for lost wages from heat stress on a day when she received a payout of Rs 400 as part of an ongoing parametric heat insurance scheme for members of the Self Employed Women’s Association. Most parts of north and northwest India are reeling under severe heatwave conditions and record-breaking temperatures. “I used the money to put some food on the table and run my house,” she told Mongabay-India.

The programme run by SEWA is one of several others to have mushroomed in the country in recent years, in response to rising floods, heat stress, and loss of productivity in renewable energy plants.

But the benefits of parametric insurance are limited by how risks and damages are perceived. India’s experience with parametric insurance is still a work-in-progress, and experts say it must complement existing climate adaptation strategies, and not replace them.

Parametric schemes in India

Natural disasters mark almost every part of India’s map. According to a report by the Centre for Science and Environment, India saw natural disasters nearly every day in the first nine months of 2022. Between 2019 and 2023, the country faced damages worth $56 billion due to weather related disasters.

Finance for disaster management in India typically comes from the National or State Disaster Response Fund and international aid. The National Disaster Management Authority contributes between 75% and 90% of funds from the central government, with the remainder supplied by the state government.

These funds are not always immediately available, however. Several state governments have moved court over the delay from the central government in releasing funds at times of crisis. International humanitarian aid is another useful avenue, but can be unpredictable, and “makes it difficult for countries to fully comprehend the value of risk reduction or the full cost of managing hazards,” Morten Broberg, professor of law at the University of Copenhagen, wrote in a 2019 paper on parametric insurance.

By contrast, parametric insurance is seen as a form of climate change adaptation because it helps governments assess, in advance, the possible damages following a catastrophic event. It can also help maintain financial liquidity by providing payouts without any stops when parameters are met, thus enabling rehabilitation and restoration to happen faster.

Nagaland is the first in India to insure its entire geography against heavy precipitation through parametric insurance. Nagaland faces heavy rainfall every monsoon season, and the low-lying parts of the state are especially flood-prone. In 2017, the state was devastated by floods that killed 22 people, completely or partially destroyed 7,700 homes, and affected a third of the state’s population. Between 2018 and 2021, incidents of water and climate related hazards increased from 337 to 814, according to the state government’s own disaster statistics report. “Nagaland is a small state, and the damages from these types of events run into hundreds of crores, which can’t be supported by the SDRF alone,” said Johnny Ruangmei, joint chief executive officer of the Nagaland State Disaster Management Authority.

Labour associations, comprising some of the most financially vulnerable populations, are also turning to parametric insurance to recover from climate induced losses.

Last year, the Self Employed Women’s Association piloted a heat insurance scheme for 21,000 of its members in four districts in Gujarat, in agreement with the Adrienne Arsht-Rockefeller Foundation Resilience Center and insurer Blue Marble. The scheme set a temperature threshold beyond which payouts would be triggered to each participating member. Alongside insurance, SEWA also implemented other climate adaptation techniques, such as providing solar powered water coolers, and providing tarpaulin sheets, to improve resilience. “We felt like it was necessary to develop a solution after we saw how many of our members suffered wage cuts during the heatwave in 2022,” said Sahil Hebbar, the wellness program coordinator at SEWA.

In Kerala, the state’s Co-operative Milk Marketing Federation, the KCMMF, is also experimenting with parametric insurance to insure its dairy farmers against losses incurred from low milk yields caused by heat stress.

Problem of ‘basis risk’

Parametric insurance schemes use intricate calculations to estimate the magnitude and frequency of a given hazard over time and relate it to corresponding values of damages in order to decide the threshold at which payouts should be triggered. These factors also determine the total sum insured and cost (premium) of the insurance cover. At the core of all of these calculations is the choice of data underlying the scheme.

“In a lot of developing country governments there often aren’t large numbers of people with the specific actuarial skills to make the relevant calculations. When you have really complex models involved, there is often not much transparency into why the model triggers payments in some cases and not others.” said Nicholas Bernards, associate professor of global sustainable development at the University of Warwick.

Despite facing heavy rainfall and floods, payouts by the insurer were never triggered in Nagaland during the years it piloted parametric insurance in the state. “We realised that the data used to form the parameters was very different from the reality we were seeing on ground, and the threshold had been set too high. At such a high threshold, huge parts would have been swept away, and we would have lost more than what was covered,” said Ruangmei.

Nagaland entered into a pilot parametric insurance agreement with Tata AIG as the insurer and Swiss Re as the reinsurer (to whom the insurer can transfer its own risks) from 2021 to 2023. The state government paid an annual premium of approximately Rs 70 lakh for a coverage of around Rs 5 crore, with the trigger threshold initially set between 290 and 350 mm of rainfall. The dataset used in the agreement was the NASA supported CHIRPS satellite data. But the government later realised these estimates varied from the India Meteorological Department’s gridded datasets as well as what was captured by its own weather stations.

This problem, when losses occur but the threshold of the scheme isn’t met, is called basis risk. It can be a further strain on resources if losses have to be borne on top of an expensive premium. “Particularly when commercial insurers are involved, there’s also a problem of conflicting interests. Insurers benefit from very precisely defined and ideally more stringent trigger conditions. Users have an interest in the opposite. In practice these are often treated as highly technical questions in which potential buyers of insurance are not directly involved,” said Bernards.

Since concluding its pilot last year, the NSDMA spent a year examining its own weather and post-disaster data and studying different insurance models to determine what parameters would suit its needs best. In February this year, the state government put out an Expression of Interest calling on interested insurers to come forward with a bid to insure the state against heavy precipitation, emphasizing it wants a solution that will “maximize the relevance of ground weather station data.”

“We received a number of bids from prominent insurers and reinsurers, which shows there’s a growing interest in the insurance market to fund this type of programme,” said Ruangmei. Nagaland is likely to sign an agreement with a new insurer and reinsurer later this month, for a coverage of around Rs 50 crore.

SEWA, too, faced a basis risk problem during its pilot in the summer of 2023 when no payouts were triggered. It has since worked with its partners to adjust the temperature threshold to a more suitable range, loosen the parameters, and open up the scheme to 50,000 members from three states – Maharashtra, Rajasthan, and Gujarat. As per the new design, for a payout to be triggered, daytime temperatures must stay above the temperature threshold for two consecutive days, as opposed to three in the pilot. The lowest trigger threshold temperature was 41.5 degrees Celsius in Udaipur, and the highest was 45 degrees Celsius, in Barmer.

“We’re learning that the temperatures at which labourers work are typically much higher than what satellite or meteorological data is able to capture. For now, our design and trigger relies only on daytime temperatures, but in the future we definitely want to integrate more parameters, including humidity and night time temperatures,” said Hebbar.

But even by casting a wider net, the benefits of parametric insurance alone are unlikely to be sufficient for those worst affected by climate change. Jashiben illustrated this limitation succinctly. “Yes, I’ve benefited from the scheme,” she said. “But I haven’t been to work for 15 days due to the heat, and I’ve received a payout for only one day. Rs 400 is fine, but what I really need is Rs 4,000 to make up for what I’ve lost.” she said. In the absence of a steady income, and with mounting medical bills from the heat stress, Jashiben said she was struggling to send both her children to school. “I may need to take a loan from a local moneylender to cover my expenses this year,” she said.

Global inequity

Insurance has been considered a solution to deal with the impacts of climate change as early as 1991, when the United Nations Framework Convention on Climate Change began, Broberg from the University of Copenhagen notes. But the popularity of parametric insurance in recent years is buoyed by the willingness of high income countries to facilitate its adoption in low and middle income countries facing the worst impacts.

Critics see the rising popularity of climate insurance as a way for high income countries to transfer their financial obligations under international conventions onto the private sector. Before the global Loss and Damage Fund was announced at the 27th Conference of Parties (or COP27) under the UNFCCC, high income countries had raised the pitch for insurance as a solution to adapt to worsening disasters.

Because of the many steps involved in designing parametric insurance, as well as the higher risk borne by the insurer, premiums for parametric insurance are significantly higher than more conventional forms of insurance. Both Nagaland and SEWA are relying on philanthropic funds to help finance the cost of premiums.

These costs and limitations have also raised equity concerns, about the extent to which it’s fair for low- and middle-income countries to insure themselves against the worst impacts of climate change despite contributing the least to the problem.

“Climate damages don’t only consist of catastrophic events. There are slower moving disasters including people’s heightened exposure to heat stress at work, or the loss of agricultural productivity to things like heat, pests, or irregular precipitation, which often translates into deepening problems of over-indebtedness. These rarely involve insurable single events. The Loss and Damage Fund has to be able to compensate for the latter too – through things like funding climate-resilient infrastructures and housing, or generous social protection,” said Bernards.

Future of parametric insurance

Insurance penetration in India remains very poor, with more than 90% of exposures to natural disasters being uninsured.

A former executive with a leading global reinsurer told Mongabay-India that the company had approached at least five states – Andhra Pradesh, Himachal Pradesh, Uttarakhand, Sikkim and Kerala – with a proposal to implement parametric insurance against various disasters, but they were met with hesitation. “There is a trust deficit as far as the word insurance is concerned. States always cited anecdotes of insurance not paying, so there’s a need to make governments aware of how exactly parametric insurance works,” the former executive said.

Nonetheless, Swiss Re expects premiums to grow by 7.1 percent over the next five years in India. Nagaland’s Reungmei is also optimistic that when the state launches its new parametric insurance model larger states will be willing to replicate something similar. “Such schemes need to create a win-win scenario for both the client and insurer. It can’t just be at the benefit of the insurer, and that’s what we are trying to do.”

Parametric insurance is emerging in India at a time when the global insurance market is undergoing several changes on account of climate change. In the US, there are reports of insurers withdrawing from markets or reducing their capacities because of higher and more unpredictable risks.

According to Tomar of AXA Climate, the looming challenge for insurers is to account for the future impact of climate change in their risk modeling exercises. Typically, risk modeling uses historical data to determine the return period of a particular catastrophic event. “Over the last decade or so, the return period calculations are going awry because these events are becoming more frequent,” he said, adding, “Insurers and reinsurers are being compelled to include an explicit input for climate change in their models which would, essentially, mean that the return period calculations are no longer based on historical data alone. This could have huge implications on not just price, but also the risk and whether insurers are willing to bear it.”

Even as the reach of parametric insurance grows in the face of rising climate impacts in India, it can’t be a stand-alone solution, said Nidhi Upadhyay, deputy director of global policy and finance at the Arsht-Rock Foundation, which helped design SEWA’s scheme.

“Our approach considers how to combine risk transfer – the insurance piece – with risk reduction to make heat resilience accessible and equitable. Especially in India, the informal sector is massive, and it can be challenging to scale insurance coverage outside the formal employment infrastructure,” she said, adding, “Scalability is the key to making this more affordable. Over the long-term, an initiative such as this needs to be taken on under a government social protection program or similar, that covers the informal sector of India.”

This article first appeared on Mongabay.