A product revolution could be brewing in the insurance sector:
Insurance has always been a tough product to manufacture (underwrite) and a tough product to sell. But there is a glimmer of change on the horizon, in the form of parametric insurance. How is it different? Fundamentally, it is a contract that insures a policyholder against a specific event, and if the event happens a set amount is paid based on the magnitude of the event. This is unlike traditional insurance which pays against magnitude of actual loss. The amount payable, the parameter and a third party responsible for verifying that the parameter was triggered – all these are in the parametric policy. The third party will usually be a government agency. For the insured, payments are quicker – usually made in a matter of days or weeks after the specified event occurs, as against months or years in the case of traditional insurance policy.
Parametric insurance solutions have been available since the late 1990s, but have become popular in corporate insurance recently. Newer products are being developed around the world and are often described as ‘elegant solution for risk-transfer concerns’. Parametric insurance is being introduced in Africa and south-east Asia, where extreme weather is a common problem. Sri Lanka has a unique parametric product – offered jointly by charity Oxfam and insurance company Sanasa Insurance – for possible losses due to natural disaster in cultivations of rice, pepper and cinnamon, which are the country’s major items of agricultural exports. The product has inherent processes based on distributed ledger technology to cover risks and uses weather stations to automatically trigger claims.
“Parametric insurance in India is a fairly new concept and will slowly gain momentum in our country,” says Tapan Singhel, MD & CEO at Bajaj Allianz General Insurance. He points out that as of now, it is majorly being used by the government under the weather-based crop insurance scheme (WBCIS) with index, to assess the damage to crops.
POTENTIAL IN INDIA
“I believe that parametric insurance has a huge potential in our country,” avers Singhel, adding: “We see risks becoming increasingly diverse and unpredictable. With renewable energy generation gaining momentum, we will see parametric insurance for renewable energy considering its unpredictable power sources and the corresponding financial risks.” Natural calamities undoubtedly set back an individual by years in his/her life, with the kind of damage they can do to assets – and parametric insurance for such events is the need of the hour to ensure that there is stability in the society, and consequently in the economy.
He is of the view that parametric insurance with triggers like magnitude of the earthquake, wind speed of a tropical cyclone or water levels for flood/rainfall intensity will go a long way in bridging the painful gap between economic losses and insured losses.
Additionally, parametric products for banks to cover NPAs due to nat-cat events and also for risks which are hard to insure like transmission and distribution lines, land value, etc, can be explored in the future.
S. Sreedhar, Managing Director at Royal Sundaram General Insurance, says weather-based crop insurance is the most popular insurance product in India currently under parametric insurance. “There have been various agriculture-related parametric covers in India since 2003, but there has not been much uptake for these covers due to high risk and cost involved. There is tremendous scope for such products, particularly, in disaster risk financing for the state governments,” he adds.
He points out that recently the Nagaland State Disaster Management Authority had signed an MOU with Tata AIG (backed up by Swiss Re for reinsurance support) to provide insurance protection for this year’s monsoon season – that is parametric insurance for excess rainfall events leading to severe flooding. “While the above cover is only for monsoon, a similar concept can be applied to other natural catastrophes with an agreed trigger that does not indemnify the pure loss but ex-ante agrees to make a payment upon the occurrence of a triggering event. With the increase in the frequency of catastrophic events in India and the disparity between economic and insured losses, these covers will provide the necessary relief to central and state governments. These covers are common globally but are generally not cheap which would explain the low uptake in India,” says Sreedhar.
Sanjay Datta, Chief – Underwritings, Claims and Reinsurance at ICICI Lombard General Insurance, explains that parametric products are of various types and in India weather-based insurance WBCIS, is popular and it works on various parameters like temperature, rainfall, humidity, etc. It helps in better understanding of the products and it becomes easier to name the risk like earthquake insurance,” says he.
Parametric insurance looks like the apt response to risks arising from frequent weather disturbances.
Ravichandran N, CTO at Kotak General Insurance, too maintains that the most popular form of parametric insurance product in India is weather insurance for farmers, which caters to trigger-based cover for farm activities. “In near future, I foresee growth prospect in parametric insurance in the form of ‘Solar Shortfall Insurance’ and livelihood protection to protect economically weaker sections against natural disasters. One can also expect peril specific parametric cover for commercial as well as retail households to complement conventional
insurance protection,” he adds, indicating the huge scope.
Another use of parametric insurance is travel industry – to cover flight delays and cancelation, avers Dr Shreeraj Deshpande, Chief Operating Officer at Future Generali India Insurance. He explains how information regarding delays and cancellations is received by the insurance companies directly from the airport authorities as well as apps that provide information. “So, if a flight gets delayed for more than 3 hours, then that information directly goes to insurance companies’ internal system and claims get paid to the insured passengers. This is the most common thing that insurance companies have adopted, these days,” says he. Such products are easy to sell as well.
Deshpande also says crop and weather index-based insurance are the 2 types of agriculture insurance. “For example, in weather index-based insurance, if 60% of the rainfall has not happened, then damages are paid to the people staying in that area and covered by insurance. The percentages can be defined in the policy. Insurance companies are dependent on the weather bureau for the information,” he explains.
He suggests that India must have similar parametric products for earthquakes. For example, if an earthquake crosses the Richter scale 6, even irrespective of whether there are damages or not, insurance amount gets paid to the insurer based on the indicators.
Adarsh Agarwal, Appointed Actuary at Digit Insurance, too points to weather-based crop insurance as a parametric insurance product in India. “Other than this, there are no significant parametric insurance products, but some insurance companies are offering insurance against loss of revenue for windmills and solar power plants resulting from low wind/sun,” he adds.
Balaji Cuddapah, President – Commercial Lines SBU at Liberty General Insurance, says WBCIS is intended to mitigate the hardship of the insured farmers against the likelihood of financial loss on account of anticipated crop loss resulting from adverse weather conditions relating to rainfall, temperature, wind, humidity, etc. He sees immense potential for such insurances for covering cover contingencies such as flight delay and cancellations in travel insurance, wellness incentives under health insurance, etc.
“Parametric covers can be a good risk mitigating tool in the management of catastrophic perils like flood, earthquake, etc, and help in bridging the protection gap,” he adds.
Nirmal Bhattacharya, Chief Underwriter at Universal Sompo General Insurance, too refers to the insurance cover against floods offered in Nagaland and believes such covers may be devised for other catastrophes like earthquake, forest fire, cyclone, etc.
Tapan Singhel of Bajaj Allianz General Insurance says a comparison between traditional insurance products and parametric insurance is not possible as under parametric insurance, the pay-out is as per the exceedance of the parameter threshold, while in the case of traditional insurance it depends on the occurrence of insured loss. Parametric insurance, he points out, is considered to be the hedge of uninsurable risks, which may not be possible to cover under traditional products.
For the customer, 2 options are better than 1.
PARAMETRIC HOME INSURANCE
“One of the key things about this insurance is that it enables a quick pay-out to the insured. I have been proposing for a long time in multiple forums that the government can introduce an affordable parametric home insurance scheme in association with insurance companies that can cover losses to property during nat-cat events. This has become even more important considering the increase in frequency of such events. An index-based scheme can be adopted to compensate for the damage caused due to catastrophic event, as per the pre-defined triggers for such events. The premium for the same can be collected along with the property tax and once the claim is triggered, the amount can be directly transferred to beneficiary’s Jan Dhan account linked to the home insurance policy. Thus, it would help people lead a life of dignity and recuperate faster from losses,” he elaborates.
Ravichandran of Kotak General Insurance explains parametric products are easier to design and administer and claim settlement is faster as the payout is based on an index and removes the need for loss adjustment. Besides, it brings in transparency to both the insurer and insured. Transparency is a powerful factor that enables trust, which is a pillar for doing business.
“However, on the other side, the payment may differ from the actual loss. Also, it requires an objective and accurate historical data to structure a solution. Nevertheless, it is an effective tool which addresses the shortcomings of traditional insurance to otherwise uninsurable risks,” he explains.
Sreedhar of Royal Sundaram General Insurance explains that the biggest pro from the policy-holder’s perspective is that the loss settlement happens quickly as the trigger criteria is straightforward, once established. So, the relief will be provided quickly as compared to traditional insurance where the loss settlement happens post-survey and assessment, which is often time consuming. “The con would be that the actual loss can be different from the loss payout condition agreed to resulting in either short (underinsurance) or excess payout benefit to policyholder compared against the actual loss,” he explains.
COMPLEMENTS TRADITIONAL INSURANCE
Shriraj Deshpande of Future Generali emphasizes that parametric insurance products may not be able to replace regular insurance products. “It can be used for travel insurance by way of travel delay product, but nobody purchases the travel delay product. Everyone opts for a comprehensive travel insurance product,” he points out.
Parametric insurance, he states further, is possible in the agriculture insurance segment, where insurance can be based on the crop cutting experiment and on the individual approach. But individual approach is lesser dependant on weather conditions. “Agriculture insurance is 90% crop and 10% weather based in India,” he adds.
Sanjay Datta of ICICI Lombard General Insurance reminds that regular insurance products are indemnity products and based on investment. On the other hand, says he, parametric products are structured, fixed pay-outs happening when there is a trigger. These insurance products are able to attend to events which are rare but impacts many people. This contrast is definitely meaningful.
Liberty General’s Balaji Cuddapah also says regular insurance policies are triggered by actual loss of or damage to a physical asset and includes deductibles, exclusions and conditions. “However, parametric insurances rely on set parameters / indices, a pay-out grid and defined compensation / coverage. Some of the advantages of parametric insurances are quick / instant compensation, wider coverage, lesser number of restrictive conditions and exclusions, guaranteed pay out when pre-defined parameters are met i.e. insured event exceeding parametric threshold. Insurance payments are made simpler without the burden of proving a claim. However, parametric insurance carries a higher basis risk,” he posits.
Nirmal Bhattacharya of Universal Sompo points to a distinct difference: “For the traditional insurance products, the policy holders pay premium and they are covered if an incident or event happens. But payments are generally made after an investigation or assessment has been carried out. This is underpinned by the idea that the cover will put the person to the place they were immediately before the loss. However, with parametric insurance, there is no assessment and the agreed payout occurs once the agreed metric is reached, which could be based on everything from wind speed or temperature to rainfall.” Quite a difference indeed.
Adarsh Agarwal of Digit Insurance argues that in parametric insurance, claims administration becomes easier, since no question on admissibility/claim amount assessment is required. However, like how a customer might get a claim settlement without suffering a loss, a customer may suffer a loss and yet not get the claim – opening the doors to confusion and resentment. “Careful examination of correlation of insurance and insured loss is very important for product designing,” he avers.
Underwriting traditional insurance is a challenge….what about parametric insurance?
Adarsh says that unlike traditional products, underwriting skills require knowledge of weather and geology in the case of parametric insurance. Someone should be able to predict and interpret weather models. “Underwriting and designing such products are difficult. Establishing correlation in insured loss and claim incidence occurrence is especially important. Pricing is another challenge,” he says, adding Digit Insurance is not thinking of launching such products as of now. Some homework is definitely needed.
Singhel explains further: “Underwriting of parametric insurance products is very different as it doesn’t have much of historical loss experience. Hence, it’s difficult to arrive at burn cost (which is normally used in regular insurance products). For parametric underwriting, stochastic models are widely used to calculate the damage factors and fix pay-outs. For instance, in case of flooding, parametric trigger is based on the accumulated rainfall (amount of millimetres within a specific time-period, eg 10 days) for each pre-defined hazard zone. Depending on the hazard zone, severe flooding can be triggered by different amounts of rainfall occurring within an aggregated number of days. Hence the pre-defined hazard zones are clustered into different categories (e.g. low, medium and high hazard zones). Stochastic models help in determining the return periods, which translates to damage factors and aids in arriving at a price for the specific cover.”
Sreedhar pitches another dimension. He says traditional insurance includes deductibles, exclusions and conditions that balance insurer and insured interests. Parametric insurance, on the other hand, determines risk using pre-defined parameters (eg, selected index), a pay-out matrix and the defined limit. Both types of cover do have a basic risk.
“However, the basic risk tends to be greater for parametric solutions as it requires the clients to have an in-depth understanding of their exposure to the peril in question,” says he, adding: “Hence, if the trigger design is not well aligned with the underlying risk exposure, the insured will suffer a loss net of the insurance payment. The underwriting for parametric insurance requires an in-depth understanding of the exposure to the peril in question and a well-aligned trigger design, in a way it involves more sophisticated technique and modelling.”
There is more. Underwriting in parametric insurance is done at the portfolio level, points out Ravichandran, based on objective historical data and hence individual risk is not assessed. Whereas in regular insurance products, underwriting is done on the quality of the risk on a case to case basis.
DATA DRIVEN PRODUCTS
Abundance of data is a big positive for parametric insurance. Sanjay Datta points out that parametric insurance products are data driven and hence the availability of long-term data, accuracy, period, and history of the data are especially important. Since this is the case, says he, the source of data based on which claims information is to be given should be independent, and data should not be tampered.
Shreeraj Deshpande opines that parametric insurance products are difficult when you design them, but the underwriting of these products is easy. “If you give a product for a particular location with fixed parameters and if it achieves that parameters, insurance companies provide claims for it,” he explains simply.
Balaji Cuddapah also feels parametric insurance requires superior product design capabilities, appreciation of climate risks, data generation and modelling skillset, leveraging of AI and newer technologies. Nirmal Bhattacharya adds that while regular insurance products can be underwritten at pre-determined rates computed on the basis of actuarial analysis, parametric underwriting is more dynamic based on actual data for the specified insured contingency and also for deciding trigger point and compensation payable. Big data and analytics are sure enablers for this.
There are regular insurance products popular in the market. But it may not be easy or feasible to create parametric version of such products. Sreedhar concurs saying products which are guided by principle of indemnity like liability would generally not be feasible as parametric insurance products would ideally be a benefit product.
Singhel says parametric insurance has many advantages, but it is primarily used for uninsurable risks. “For traditional products,” he explains, “the indemnity matches the loss on occurrence of insured loss. Hence, the traditional products such as commercial insurance (industries / home / marine) would always be required. Parametric insurance helps in bridging the gap. Lack of sunlight which affects the production of solar plant is not covered under traditional insurance, but it can be covered through parametric insurance.”
Ravichandran posits that parametric insurance is a complement to traditional insurance products and not a substitute. It is useful in a pure economic loss and exposure to natural catastrophic events, he adds.
Shreeraj Deshpande is emphatic that parametric insurance products cannot become stand-alone products; they can complement and supplement regular insurance products. There are ways in which insurance companies can introduce parametric insurance products, which may not indemnify the loss they suffer, but it should supplement the actual loss. The gaps are covered by the parametric insurance products. It is still in the development stage, but requirement of this product will increase in the coming years. “We should look for simpler products that are digitally available,” he avers, which is quite in line with the new trend.
Adarsh Agarwal maintains that wind/solar power industry can use parametric insurance products. Large manufacturing companies can also use it for business interruption. Companies, where revenue is dependent on weather can use it – such as commodity warehouses, he cites.
NO SPECIFIC REGULATIONS
What is the status of regulations for parametric insurance?
Sreedhar says currently, there are no specific regulatory guidelines relating to or focussing on parametric insurance. “However, IRDAI had released regulatory sandbox regulations in 2019, which are aimed at promoting innovation in insurance in India. These essentially provide guidelines for insurance companies to make an application to the authority for the insurance product or any other innovation in a specific format and upon reviewing the information, it can grant permission whose validity is for a period of 6 months,” he elaborates.
Singhel, however, says the regulator has given approval for parametric products such as solar and other covers. Sanjay Datta explains that structuring the product is particularly important and key for regulatory guidelines relating to parametric insurance. “How you measure the data for parametric insurance claims should be clearly available,” he avers.
Pointing out that there is no specific guideline relating to parametric insurance, Ravichandran says, however, a suitable product needs to be filed with the regulator as per product filing guidelines before introducing it in the market.
The biggest fear for insurance is frauds. How fraud-prone is parametric insurance?
Fraud is not at all possible in such products, since insured has not even a slightest control on claim incidence, argues Adarsh Agarwal. Since they are very transparent, parametric products are less prone to frauds, argues Singhel. Besides, payments are made upon the occurrence of a triggering event and the triggers are pre-defined and measurable.
“An independent third party is pre-agreed from where data source would be collected to measure exceedance of parameter threshold and accordingly pre-defined and quick pay-out is made,” he explains further.
According to Sreedhar, even in more developed markets, these products are currently niche products and are specifically designed to suit the needs of the insured exposed to natural, catastrophic perils and the product design takes into account exposures, past history of losses and modelling outputs, triggers, payouts and pricing for the set triggers, which is normally high. Claim payouts are made based on defined triggers and there is pre-defined clear-cut understanding of what the triggers are and the basis of reckoning them.
“Therefore, I do not think these products are more prone to fraud,” he claims.
Shreeraj Deshpande has a different explanation: “The parameters for the parametric insurance products come under the third party, so neither the insured nor the insurance company has control over this parameter. So, chances of frauds are removed.”
Pointing out that insurance frauds are universal in nature, Balaji Cuddapah highlights that parametric insurance does away with elaborate claim adjusting process and are faster in disbursing the payout. “As the payout is dependent on occurrence of an event rather than magnitude of the loss, it is assumed that frauds are lesser here,” says he.
All the respondents so far have given a very positive perspective. Nirmal Bhattacharya, deviates slightly: “Since no assessment is required following loss for such products and pre-agreed pay-out is made to the client in case of any deviation from the trigger point, possibility of fraud may not be ruled out. However, such situation can be avoided by close monitoring of the insured portfolio.”
Adds Ravichandran: “The advantage in this type of insurance is that it avoids adverse selection, which eliminates issues at the time of claim. As it is the case in any other product, monitoring and administration of such products is important.”
While parametric insurance is more in vogue in more developed markets like America and Europe, it is particularly popular in regions like the Caribbean that are prone to natural catastrophes. Nirmal Bhattacharya cites the instance of CCRIF SPC (formerly the Caribbean Catastrophe Risk Insurance Facility Segregated Portfolio Company), developed under the World Bank’s technical leadership, as a pioneering regional fund utilizing parametric insurance to cover catastrophe-related losses. Each nation benefits from quick pay-outs even before actual damages are assessed, providing much needed financial liquidity that is critical for recovery efforts. “This was also the motivation behind the record $1.36 billion CAT bond issued by World Bank in the past which relies on parametric triggers to cover earthquake risks in Chile, Columbia, Mexico and Peru,” says he. All these are developing economies like India.
He also refers to AXA Climate, a subsidiary of global insurance company AXA, releasing a mix of weather-related risk, including lack of sun resulting in less power for China’s solar firm and also the impact of drought on Nigeria’s small holder farming community.
Also, innovative index-based risk transfer solutions have been used extensively across the globe, especially in the US, the UK and Bangladesh for relief in flood havoc. Singhal points out to the Indian government using parametric insurance for ‘disaster risk financing’.
He adds: “There has been push for renewable energy in many countries. Hence, there’s an uptick of parametric insurance cover for lack of solar irradiation cover, which has also started in India. To name a few global instances, Uruguay has a parametric product for energy production shortfall due to drought, Caribbean for earthquake and hurricane risk and Bangladesh for flood protection.” Given India’s massive push towards sustainable and renewable energy, can the country afford to lag in parametric insurance for these projects?
The risking risks to business from all kinds of natural calamities and extremities, the grit with which insurance companies are innovating, the ability to use analytics to underwrite parametric products, the easy availability of a wide variety of data, the rising levels of digitization and automation – all these factors are coming together in 2020 to create tremendous opportunity for parametric insurance to emerge as a practical alternative to traditional insurance.
Banking Frontiers will continue to unveil more stories on parametric insurance and other such new opportunities.