How will the future climate affect insurance?

The (re)insurance industry often discusses the coverage gap – the large and increasingly widening global coverage gap which exists for insuring global climate events and weather catastrophes in broader conversations about mitigating climate risk. The challenge, of course, is how we begin to chip away at this concerning gap. In 2021, 400 plus record disaster events resulted in $343 billion in economic damages globally, according to Aon. Nearly two-thirds of these losses were not covered by insurance programs, with 50 plus separate billion-dollar weather events recorded in 2021 – the fourth highest for a single year. From devastating floods which ravaged Europe in July of last year to wildfires in California and severe droughts in West Texas and other parts of the continental United States, seasonal and catastrophic climate disasters are increasing in frequency, intensity, and overall financial cost. Unfortunately, the financial system and the (re)insurance sector are unprepared to analyze, assess, and manage these risks. 

The insurance industry has the opportunity to meet this challenge by introducing scalable and efficient solutions which enable stakeholders across the financial system to build long-term resilience and offer traditionally underserved stakeholders impacted by climate risk the most urgently tailored coverage solutions. 

This is where parametric comes in.

The basics
Parametric insurance is a type of insurance product that pays out for a specific event like a hurricane or drought by insuring based on a pre-agreed data trigger. The client becomes eligible for a payout if that pre-agreed data trigger is met during the coverage period. Because all of this is data-driven – with payouts typically triggered by pre-determined datasets that the insurer and the insured agree to – drawn-out and often subjective claims processes become a thing of the past. This brings much-needed speed, scale, and transparency to the coverage process, essential for closing the sizable global coverage gap for seasonal climate events and weather catastrophes.  

The speed component is important: payouts for catastrophic events like hurricanes can take months to even years. For example, claims and associated litigation tied to Hurricane Irma were still being dealt with nearly three years after the storm made landfall as a Category 4 hurricane in September 2017. Indemnity insurance is a multi-step process that involves an assessment of the damage followed by a claim from the insured. This is then reviewed by the insurer, which is assessed in most cases on the severity of the damage, which can be difficult to accurately or subjectively calculate. Parametric adds key value in settling claims for catastrophic events like hurricanes quickly. Once the qualifying event is verified against objective, third-party data (most U.S. policies leverage National Hurricane Center data), an insurer can issue a payout within weeks, not months or years. This adds value both to the insurer and the insured and enables businesses, individuals and communities to build long-term financial resilience against climate risks - which are only becoming more frequent and severe with each passing season. 

Parametric insurance, especially when leveraging digital tools like AI, machine learning, and blockchain to introduce operational efficiencies for pricing, sending payments, etc. can add much-needed scale for insuring traditionally underserved stakeholders. For example, insuring subsistence farmers in developing regions and other stakeholders exposed to climate risks in geographically expansive regions where a boots-on-the-ground approach to insurance is simply not feasible. Additionally, climate datasets – especially with advancements in satellite technology and geospatial intelligence – are only getting better and more granular, enabling insurers to underwrite risks where limited data history or availability was previously a bottleneck while reducing basis risk. 

While parametric or index-based insurance has often been considered a tool for providing supplemental coverage for catastrophic events like hurricanes, these products can be impactful as primary or supplementary coverage products for protecting businesses against seasonal climate events. Seasonal climate events like drought or excess rainfall are non-catastrophic in nature but can have a catastrophic impact on supply chains and critical infrastructure. What starts with a missed crop for a farmer eventually hits the pockets of the processor that depends on that crop yield for its production and then up the food chain. 

McKinsey found in a recent study that 14 percent of global rain-fed cropland was impacted by moderate to severe drought conditions between March and August of this year, representing $6 billion of total production value. Seasonal and catastrophic climate perils can be proactively managed using data-driven risk management tools to build financial resilience into the entire value chain of any given operation. 

While the global coverage gap remains sizable, data-powered parametric policies supported by a digital ecosystem of tools for bringing efficiency to pricing execution and delivery of payouts are well-positioned to chip away at this gap. With 70% of businesses worldwide exposed to these risks, the urgency to introduce scale and efficiency to climate risk management is urgent. 

The future of climate insurance 
As climate events and major weather catastrophes are predicted to become increasingly frequent, severe, and financially devastating, the industry needs to embrace innovation to solve the key problem of how insurers and reinsurers can provide well-structured climate resilience products which meet the needs of stakeholders — from farmers to energy companies to banks and multinational corporations around the world. Parametrics not only introduces cost savings on the underwriting and assessment sides of the business but enables the development of globally scalable products which pay out quickly and fairly when a significant climate event or weather catastrophe occurs. 

Parametric insurance is quickly becoming more popular among insurers looking to offer climate resilience products due to its ability to simplify and expedite claims payouts. The introduction of global datasets and AI underwriting capabilities make these tools not just globally scalable, offering coverage opportunities to stakeholders with few insurance options but the opportunity to cover a growing number of concerning perils. Parametric insurance — powered by market-leading data and cutting-edge technology — can revolutionize how insurers handle climate-related risks in the future and help the industry chip away at the troubling global coverage gap in a way that delivers trust, efficiency and resilience to the entire global financial sector.