What is parametric insurance and how is it building climate resilience? 

The landscape of climate risks is growing, but strategies to mitigate these impacts and protect vulnerable communities and economies are also rising.

Among those stakeholders developing measures, the insurance industry stands uniquely equipped with the tools, expertise and risk management capabilities to lead the response to climate change.

Amid an increasingly volatile climate risk landscape and challenging underwriting conditions, insurers are increasingly turning to parametric insurance to fill protection gaps and protect vulnerable communities and economies from climate risks.

Also known as event or index-based insurance, parametric products trigger payouts when specific conditions are met, such as certain levels of rainfall or wind speed.

These pre-defined triggers and measurable indexes bring more transparency, expedite claims processes and payouts, and reduce administrative and frictional costs.

Importantly, the policyholder can use discretion when utilizing parametric payouts, providing more flexibility than traditional indemnity policies. Ultimately, these attributes strengthen the resilience of vulnerable communities.

Unlike traditional insurance, which is based on the actual losses sustained, parametric insurance is linked to a specified event. This expands the scope of coverage and addresses gaps that conventional policies often leave unprotected.

By leveraging publicly available weather data, such as rainfall, wind speed or temperature, parametric products reduce information asymmetry between policyholders and insurers, ensuring a more transparent and efficient response when climate disasters strike.

As climate risks become more frequent, intense and prolonged, parametric insurance offers a crucial tool to help mitigate direct and indirect losses.

Over the past decade, 83% of global economic losses from flooding were uninsured, highlighting the critical need for viable, scalable flood resilience solutions.

As devastating flood events become more prolific, advances in satellite technology and AI can enable insurance coverage for previously uninsurable risk over large areas such as municipalities, farms and golf courses.

Most recently, these technologies have been used to power innovative risk transfer solutions such as parametric insurance, offering new protection and financial resilience for businesses, industries and economies. This is especially critical for municipal governments, which are on the hook for millions of dollars after major floods while awaiting federal funding, which can take years.

As the historic 2024 North Atlantic Hurricane season ends, the West Coast atmospheric river season begins. These atmospheric phenomena, which can transport 15 times the water volume of the Mississippi River, cost California, on average, more than $1 billion every year. In 2023, the atmospheric river season cost California municipalities $5-7 billion in economic loss – 80% of which was uninsured.

Driven by climate change, annual damages from atmospheric rivers are projected to increase, with exposures expected to double this century.

These flood events fiscally strain local governments who must contend with a decimated tax base while simultaneously spending significant sums on relief and recovery.

Over the past two years, federal support has covered less than 1% of the projected economic losses from atmospheric rivers and many of these funds have yet to be obligated to localities on the ground.

With limited insurance options and delayed federal disaster funding, flood-impacted municipalities often struggle to rebuild their communities, balance their budgets and maintain continuity of public services.

Recently Floodbase – an AI platform for insuring uncovered flood risk – launched a flood insurance programme for California municipalities.

The company, which fuses satellite observation and ground data to provide near real-time flood monitoring to design, underwrite and trigger parametric insurance policies, partnered with Amwins, a leading distributor of speciality insurance products and services to serve local governments across the state.

The first-of-its-kind programme is designed to insure California municipalities against previously uncovered losses due to atmospheric river flooding. For credibility, it has received an A+ rating from the insurance rating agency AM Best.

These recent initiatives by Floodbase, its partners in the insurance industry and California local governments illustrate the innovative products and partnerships that can help protect economies and societies from escalating climate threats.

This innovative product is part of an expanding suite of parametric solutions that the insurance industry is leveraging to advance climate resilience.

Parametric insurance has recently been used to cover income losses for outdoor workers in India during heat waves, safeguard and rehabilitate coral reefs after hurricanes and support reforestation after destructive wildfires.

While still a smaller market than traditional insurance, parametric insurance is proliferating and is projected to reach $34.4 billion by 2033.

However, parametric insurance has its limitations. Since coverage depends on specific thresholds or trigger events, losses falling just outside these parameters may go unaddressed, potentially leaving policyholders with uncovered economic impacts.

For instance, a policy covering drought-related crop losses might trigger a payout if rainfall drops below 50mm but a farmer facing significant impacts with 55mm of rainfall would receive no compensation.

Furthermore, as climate risks intensify, the increasing frequency of payouts may challenge the sustainability of parametric products.

Despite these constraints, parametric solutions are essential for tackling extreme heat and other climate risks, particularly in vulnerable communities.

Evan Achiron, Marketing Manager, Floodbase and Benjamin McNeil, Vice President, Public Sector Solutions, SwissRe also contributed to this article.