Climate change: When parametric insurance emerges as a promising solution for rapid relief
Climate change has brought to the forefront the urgent need for innovative solutions. Floods, rising sea levels, and extreme weather events are just a few of the pressing challenges we face today. Traditionally viewed as a risk management tool, insurance has emerged as a powerful ally in mitigating the financial burdens associated with climate-related disasters as revealed in a study published by Haitham and Xuan-Hoa (2024).
By providing financial protection against unforeseen events, parametric insurance can help individuals and businesses to recover from losses, especially in the event of rapid-onset catastrophes like floods and cyclones that cause immediate and severe damage. This innovative and convenient type of insurance offers coverage based on the occurrence of a specific, measurable event, rather than the actual financial loss incurred. Unlike traditional indemnity-based insurance, parametric policies trigger payouts when a predefined intensity threshold is met or exceeded. Commonly used parameters include earthquake magnitude, tropical cyclone wind speed, and flood water depth. This means that insurers do not need to assess the damage before paying out, leading to significantly faster claims processing for clients compared to traditional insurance claims that can be a lengthy and an uncertain process, with the final payout often subject to negotiation and dispute.
Simple in concept, yet remarkably effective and swift in action, parametric insurance can be particularly beneficial for people living in Small Island Developing States (SIDs) which are often vulnerable to natural disasters like floods and cyclones. As part of the SIDs, Mauritius and other islands in the Indian Ocean, face unique challenges. Mauritius has even been classified as the 51st most exposed country to natural hazards by the World Risk Report 2021, experiencing a more rapid increase in temperatures and sea levels than the global average. In recent years, the country has experienced episodes of flash floods, torrential rain and cyclones with high intensities comparable to Category-5 hurricanes as reported by the UN Environment Programme. Similarly, Seychelles faces significant vulnerability to climate change, driven by the rising frequency and intensity of climate-related disasters, along with escalating sea levels and other oceanic changes. Additionally, Seychelles' geographic location, combined with its unique topography and landscape, makes it especially vulnerable to tropical cyclones, tsunamis, storm surges, heavy rainfall, and flooding.
An important example of how parametric insurance is being implemented on a larger scale is the African Risk Capacity (ARC) Agency, established in 2012 by the Heads of State of the African Union to address the growing frequency and severity of climate-induced natural disasters. The ARC agency's financial affiliate, African Risk Capacity Limited (ARC Ltd), was established in 2014 as a mutual insurance company which provides insurance coverage to vulnerable populations through governments and humanitarian organisations. ARC Ltd is Africa’s leading climate risk insurer with an 85% market share in climate related risk on the continent, providing insurance coverage to over 131 million vulnerable Africans across 25 countries. Over 10 years, ARC Ltd has paid out US$230 million in claims and provided coverage of over US$1.3 billion.
For islands in the Indian Ocean, vulnerable to natural disasters, parametric insurance could be a game-changer. By offering payouts based on predetermined triggers and independent data, this innovative type of insurance eliminates the need for on-site damage assessments. This results in faster claims processing and more predictable financial outcomes, making it a compelling option for businesses and individuals looking to safeguard against the unique risks faced by these islands.
