Parametric Insurance Can Tackle Climate Risks

The swift payouts based on objective data make it a versatile and responsive tool for managing climate risks preemptively.

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Photo of melting icebergs

KEY TAKEAWAYS:

--Parametric insurance allows for a greater web of protection beyond asset owners -- perhaps a government-funded index for, say, the urban poor who depend on a certain crop for their sustenance.

--With payouts based on specific wind speeds or rainfall amounts, property owners can quickly recover from damages, alleviating the long wait times and uncertainties associated with traditional claims processes.

--For businesses, particularly those dependent on complex supply chains, parametric coverage offers a way to mitigate the financial impact of unpredictable climatic events by making it possible for a company to receive a payout if a key region is hit by a natural disaster.

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Consider this: In the fall of 2022, a drought blanketed southwestern China, bringing many industries to a standstill. The drought led to a severe reduction in the country’s hydropower, which, in turn, spurred factory blackouts that curtailed electronics production. The contraction of the electronics market led to a slowing in automobile production and other electronic goods, which caused prices to soar worldwide. Moreover, the drought caused the water levels of parts of China's great Yangtze River to fall so low they hampered water transportation. According to the New York Times, the problem with water transportation caused: 

"Companies… to scramble to secure trucks to move their goods to Chinese ports, while China’s food importers hunted for more trucks and trains to carry their cargo into the country’s interior. The heat and drought have wilted many of the vegetables in southwestern China, causing prices to nearly double, and have made it hard for the surviving pigs and poultry to put on weight, driving up meat prices."

This year, a drought caused a similar throttling of hydropower production in Taiwan that reduced semiconductor production. This was the third year in a row that a record-shattering drought gripped the world’s main supplier of semiconductors; and it was the third consecutive year that the Taiwanese government subsidized rice farmers in the southern part of the country for not planting crops because of limited water resources.        

As we draw a curtain on 2023 – which featured the hottest summer on record – the world confronts an unprecedented challenge arising from climate change's domino effect. Beyond environmental degradation, drastically changing climate patterns affect everything from human and animal well-being to the connected global economy and its supporting supply chains. 

See also: Property Underwriting for Extreme Weather

The Health Emergency of Climate Change

Climate change, often perceived primarily as an environmental issue, has emerged as a dire public health emergency. The World Health Organization, in its report "Climate Change," paints a grim picture: By 2030, climate change is expected to cause 250,000 additional deaths annually due to diseases like undernutrition, malaria, diarrhea and heat stress. These figures only scratch the surface of a deeper crisis where the very determinants of health – clean air, water and food systems – are under siege. The report states:  

"WHO data indicates 2 billion people lack safe drinking water and 600 million suffer from foodborne illnesses annually, with children under five bearing 30% of foodborne fatalities. Climate stressors heighten waterborne and foodborne disease risks. In 2020, 770 million faced hunger, predominantly in Africa and Asia. Climate change affects food availability, quality and diversity, exacerbating food and nutrition crises."

The Disproportionate Burden on Vulnerable Populations

The outsized impact of climate change on low-income populations will continue to spur migratory crises that strain sociopolitical systems worldwide. The International Federation of Red Cross and Red Crescent Societies issued a report, “The Cost of Doing Nothing: The Humanitarian Cost of Climate Change and How it Can Be Avoided,” that states, “By 2050, 200 million people every year could need international humanitarian aid as a result of a cruel combination of climate-related disasters and the socioeconomic impact of climate change.”

The report also says:

"Today, resources are already insufficient to provide fundamental support to everyone who needs assistance after climate-related disasters. Depending on the amount of support provided and the source of cost estimates, meeting current needs costs international funders $3.5 billion to $12 billion annually. By 2030, this funding requirement could balloon to $20 billion annually."

If we truly want to roll back income inequality, we must prioritize climate change mitigation, because the cost of doing nothing is exorbitant indeed. 

A Crisis in American Homeownership

The world’s most economically vulnerable citizens are not the only ones threatened by climate dangers. A recent article in The New York Review of Books, "The Crash to Come," notes that insurers such as State Farm are withdrawing from regions like California due to the growing risk of climate-related disasters. This retreat is not just a crisis for homeowners but a signal of a deeper economic instability. The U.S. housing market, valued at $47 trillion, faces a climate risk bubble that could burst, causing widespread economic fallout.

Once enablers of dreams, insurance firms are now arbiters of harsh realities. Their withdrawal marks the beginning of a seismic shift in the financial landscape whose ripple effects from this will likely be felt across the nation.

See also: The Evolving Threat of Wildland Fire

Effects on the Business Community

On the business front, the next few years are expected to see substantial growth in industries directly affected by agricultural production fluctuations. Ethanol and biodiesel plants, flower processors and canning operations are just a few examples of businesses facing significant risks due to climate change.  Local processors, transporters and warehouses depend heavily on the consistent production of local crops, which can be undermined by an unexpected frost or a severe spike in temperature. A shortfall in crop production can lead to significant business disruptions across supply chains and reduced revenues.

Indeed, one significant yet underappreciated issue is the shift in cropping patterns. Traditional crops like soybeans, once limited to warmer climates, are now being grown in colder regions. However, these new areas often lack sufficient federal crop subsidies, creating a financial gap for farmers venturing into these new agricultural frontiers. 

Parametric Insurance for Today’s Risk Landscape

Each challenge to people, property and businesses, underscores the need for adaptable and responsive risk mitigation solutions that keep pace with the changing climate and its assorted impacts. Parametric insurance offers swift and accurate payouts based on objective data sources, which make it a versatile and responsive tool for businesses and financial institutions looking to manage their climate risks preemptively.

Moreover, parametric insurance allows for a greater web of protection beyond asset owners. Thus, one could imagine creating a government-funded index for, say, the urban poor who depend on a certain crop for their sustenance. Although they are not asset holders, parametric insurance can take into account the indirect effects of bottlenecks further up the supply chain. 

Likewise, in the real estate sector and urban planning, parametric insurance can be a game-changer. Advances in remote sensor technology and climate modeling mean it is, possible to create more robust predictive models that show prospective clients a comprehensive view of the risks they face. And in places such as Florida, where it can be tough to acquire traditional insurance for roofs due to the threat of hurricanes, parametric insurance can be used to fill the protection gap. With payouts based on specific wind speeds or rainfall amounts, property owners can quickly recover from damages, alleviating the long wait times and uncertainties associated with traditional claims processes.

The same is true for businesses, particularly those dependent on complex supply chains. Parametric coverage offers a way to mitigate the financial impact of unpredictable climatic events by making it possible for a company to receive a payout if a key region is hit by a natural disaster, which can cushion the blow from supply chain disruptions.

In essence, parametric insurance provides a proactive risk management tool that complements traditional insurance models. It enables businesses and communities to respond more effectively to the challenges posed by climate change, safeguarding assets and ensuring continuity in the face of environmental uncertainties. If we want to be serious about fostering resilience and adaptability in an era marked by escalating climate risks, it behooves us to make parametric insurance an essential component in our risk management toolkit.


Siddhartha Jha

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Siddhartha Jha

Siddhartha Jha is the founder, chairman and CEO of Arbol, a global climate risk solutions platform focused on data-driven parametric insurance.

Jha is also a co-founder of dClimate, the first decentralized climate information ecosystem. Prior to Arbol and dClimate, he had over 13 years of experience in the financial industry. Jha launched an agriculture futures trading portfolio, managing over $100 million at a major commodity trading firm.

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