Parametric insurance: The potential for underserved communities, SMEs

Climate change is no longer a distant threat but a tangible reality affecting communities and businesses worldwide.

The frequency of weather and climate-related disasters in the United States has increased dramatically in recent years, according to the National Oceanic and Atmospheric Association (NOAA). Between 1980 and 2022, there were 7.9 (CPI-adjusted) severe-weather events. By contrast, the past five years saw an increase of more than 100%, translating to an annual average of 17.8 major-weather events (CPI-adjusted).

These numbers highlight the urgent need for insurance professionals to address the impact of climate change’ on our communities and economy.

Small and medium-sized enterprises (SMEs) and underserved communities are especially vulnerable to climate risks. In nearly 80% of cities surveyed, the global nonprofit CDP found individuals and communities exposed to climate hazards. The most affected groups are often the elderly (64%), low-income households (64%), children (52%), marginalized and minority communities (47%), and vulnerable health groups (38%).

As a result, insurance agents and brokers are facing added pressure to offer pragmatic, risk-management solutions that provide adequate protection against the possibilities of a severe-weather event.

Traditional insurance products may be insufficient to address the impact of climate change on SMEs and affected communities in real-time. Filing a claim and verifying losses can be a lengthy process. In an emergency, time is of the essence, and a payout that takes months or sometimes even years to process may come as too little, too late.

Parametric insurance can help meet this challenge by providing coverage based on predetermined and objective data triggers instead of manual and often a subjective assessment of physical damage. This type of insurance offers faster payouts that can be used to cover losses associated with catastrophic and seasonal weather events, making it a valuable tool for businesses and economically-challenged communities to build financial climate resilience.

Types of parametric insurance products

A wide assortment of parametric insurance products can be tailored to address the particular needs of different businesses and communities. For example, some products may provide coverage for losses associated with business interruption or damage to property, while others may provide coverage for crop failures or livestock losses. Additionally, parametric insurance products can be customized to incorporate specific triggers and payout amounts, making them highly flexible and adaptable.

How parametric insurance can help

Parametric insurance can be customized to insure against adverse weather conditions, such as too much or too little rain, snow, or wind. Coverage triggers can also be set to account for storm surges, fluctuations in temperature, humidity, etc. By offering speedy payouts to cover losses, parametric insurance can help businesses and communities recover swiftly and build resilience against climate risks.

 Parametric insurance availability and accessibility

Although parametric insurance has the potential to provide much-needed protection against climate change, there are still challenges to overcome before widespread adoption becomes a viable possibility. For example, many under-resourced communities and small businesses may need to be made aware of what parametric insurance can offer. Another factor is that some providers do not offer parametric insurance products. If they do, they charge high premiums or have limited product offerings, making it inaccessible to those who benefit greatly.

Insurance agents and brokers can play a critical role in educating their clients about the benefits of parametric insurance. By raising awareness around these safeguard measures, insurance professionals may create a groundswell of demand that leads to more institutional investment in parametric options.

To accomplish this, it would behoove insurance providers to partner with local organizations, governments and community groups to help expand access to affordable and well-structured coverage options for underserved stakeholders who often have limited options for protecting themselves against climate catastrophes.

Broader implications

The impact of climate change on small businesses and under-resourced communities poses significant ethical questions that touch on corporations’ and governments’ responsibility in addressing climate change and the importance of community-based approaches to resilience-building. It is essential to recognize the interconnectedness of our society and the importance of taking collective action to address future weather volatility. Moreover, community-based approaches that involve collaboration and mutual support can increase the ability of small businesses and underserved communities to adapt to the changing climate.

As climate change continues to roil communities and businesses worldwide, the need for innovative risk management solutions like parametric insurance will only grow.

It is essential to note, however, that parametric insurance is not a panacea for all of the challenges posed by climate change. It’s only one option in a broader toolkit that must include a range of mitigation and adaptation measures. A full response requires tools that enable communities, governments and corporations to analyze, assess and mitigate risk where it already exists, and then take proactive action to reduce emissions across balance sheets and supply chains.

Parametric insurance is just one of many important tools that are needed to bring scale and efficiency to climate risk management and help power a sustainable and prosperous future.

Siddhartha Jha (info@arbol.io) is founder, chairman and CEO at Arbol, a climate risk management tech company. These opinions are the author’s own.

Also by this contributor: Closing the insurance coverage gap in risky coastal areas