Natural catastrophes, such as Hurricane Matthew that caused so much devastation and suffering in Haiti, can cause death and destruction wherever they strike.

Their effects are magnified in developing countries, where already limited public and private resources become severely strained, if not completely unavailable, following natural catastrophes.

Non-governmental organizations (NGOs) play an essential role in assisting catastrophe-hit countries and regions. Despite their best efforts, NGOs themselves typically have to scramble to raise funds following a natural catastrophe, which creates a time lag before help arrives on the scene. Every delay on the ground exacerbates the impact of a disaster. While affected areas wait for support and funding, lives are disrupted, businesses and livelihoods are lost, and national output is dented.

One potential solution to reducing this lag and uncertainty is to increase the use of parametric insurance by NGOs. For this to happen, the insurance industry must do more to educate NGOs and governments on the value of parametric coverage.

What is parametric insurance?

Insurance usually indemnifies the insured party for its specific loss from a covered risk or event, and the insured must notify and document the loss to the insurer. In contrast, parametric insurance pays the insured party a pre-determined amount upon one or more specified parameters being met.

For natural catastrophes, the parameters might be wind speed, strength of a hurricane, rainfall amounts, the magnitude of an earthquake or similar triggers for a specified geographic area. For example, a parametric product designed to respond to an earthquake could be triggered to pay if a quake of certain magnitude is measured at a certain location.

The source for the parameter or trigger is usually specified and tends to be a recognized independent third party (such as a weather or earthquake monitoring body) or bespoke data analysis system.

Traditional indemnity insurance, on the other hand, requires an assessment of the value of the insured’s loss, and the claims handing and loss adjusting process can slow down the release of a claim payment. Also, traditional indemnity insurance customarily has various conditions, exclusions and limitations that may introduce uncertainty and delay for an insured making a claim.

Documentation of losses not required

In contrast, parametric insurance doesn’t require the buyer of the coverage to document the losses it has suffered, which makes the claims adjustment and payments process faster and simpler.

The insurance industry is already well-versed in providing parametric insurance coverage. The major insurers and reinsurers have a range of insurance products that provide such coverage. In addition, the industry has seen widespread issuance over the past 15 to 20 years of catastrophe bonds, which are insurance-linked securities in which specified triggers for natural catastrophes cause a payout to the issuer of the bonds and ultimately to the buyer of the protection.

The difficulty, as with most insurance products, has been increasing penetration of such products in developing countries.

Insurance unknown in some developing countries

According to McKinsey Consulting’s “Global Insurance Insights 2015” white paper, insurance penetration in emerging markets is only about 3%. However, as noted by Lloyd’s “360° Risk Insight Insurance in developing countries: Exploring opportunities in microinsurance” paper, commercial insurance doesn’t tend to reach the poorest and neediest parts of such societies. Therefore, insurance typically doesn’t play the same valuable role in helping developing countries recover from natural catastrophes as it does in developed countries.

The reasons for the low insurance penetration in developing countries include the lack of understanding of and experience with the role that insurance can play in helping individuals and businesses protect themselves against natural and other risks. But at least one reason is the difficulty documenting and administering claims, which is a concern for both the buyer of coverage as well as the insurers.

NGOs and parametric insurance

Given the faster process and speed of payouts under parametric insurance, an NGO with a parametric insurance cover could expect to receive funding quickly after a natural catastrophe to allow it to intervene and provide aid rapidly. Or it could receive funding even before a natural catastrophe unfolds—for instance, it could receive a payout before a drought leads to a full-blown food crisis, enabling it to intervene before people begin to starve.

Encouragingly, such parametric insurance is already being used by governmental entities. For instance, the parametric catastrophe insurance facility CCRIF SPC (formerly known as the Caribbean Catastrophe Risk Insurance Facility) has paid out $29.2 million to member countries (Barbados, Haiti, Saint Lucia and St. Vincent and the Grenadines) on their parametric policies for claims arising from Hurricane Matthew; what is especially noteworthy is that the payments were made within 14 days after the hurricane. Other examples of such parametric facilities include a parametric weather insurance program in China’s Heilongjiang province and the weather risk pooling mechanism used by The African Risk Capacity which includes parametric triggers.

The advantages of parametric insurance for NGOs are clear, and there are encouraging signs that both the insurance industry and aid community are committed to developing insurance models that connect new products to “on-the-ground” humanitarian and development scenarios. For instance, the Insurance Development Forum (a body backed by the World Bank, UN and key players in the insurance industry) is taking the lead in bringing together the industry to tackle the issue of resilience; meanwhile, the Start Network, a global group of 42 aid agencies committed to changing the humanitarian system, is developing new ways of funding fast, efficient disaster response.

But everyone in the insurance industry ecosystem needs to be proactive in increasing uptake of parametric products by NGOs through comprehensive educational efforts. The industry also needs to ensure that it understands any barriers that NGOs might face when looking at this type of products — for example, whether donors would be willing to donate towards premium for a parametric cover that might never pay out. Finally, the industry could do more to increase awareness of the successes parametric insurance has already had in developing countries to show how the insurance industry can play a key part in building greater resilience to natural disasters.

Vikram Sidhu and Nigel Brook are partners with Clyde & Co., a global law firm headquartered in London with a focus on insurance, energy, trade & commodities, infrastructure and transport. They can be reached at vikram.sidhu@clydeco.us and nigel.brook@clydeco.com, respectively.

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How parametric insurance can help after natural catastrophes

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