Parametric insurance is insurance in which the payment is triggered by reference to a pre-determined parameter or ‘index’ that stands as a proxy for loss. For example, a policy designed to provide funding to a policyholder in flood or drought conditions could be triggered by excess or insufficient rainfall measured by a local weather station. Parametric insurance has wide-ranging applications, from renewable energy to flight cancellation to agriculture.

This article was originally posted on Commercial Risk Online here: https://www.commercialriskonline.com/bridging-protection-gap-novel-forms-risk-transfer/

Parametric insurance is insurance in which the payment is triggered by reference to a pre-determined parameter or ‘index’ that stands as a proxy for loss. For example, a policy designed to provide funding to a policyholder in flood or drought conditions could be triggered by excess or insufficient rainfall measured by a local weather station. Parametric insurance has wide-ranging applications, from renewable energy to flight cancellation to agriculture.

China is one jurisdiction that has witnessed huge development in the insurance industry in recent decades and a significant feature of that development is product innovation. A wide range of index-based insurance products are now offered in China. The regulation or supervision of parametric insurance is somewhat different from that of other insurance products.

Despite the fact that parametric insurance is sold by many insurance companies in China at present, there is no specific law or regulation regarding parametric insurance. The operation, selling or other relevant activities of parametric insurance shall comply with the general insurance-related rules. The relevant laws and regulations include:

  1. Regulations on Agricultural Insurance (农业保险条例)
  2. Interim Measures on the Underwriting and Settlement of Agricultural Insurance (农业保险承保理赔管理暂行办法)
  3. Measures on Premium Subsidy of Agricultural Insurance from Central Government Spending (中央财政农业保险保险费补贴管理办法) and other relevant rules issued or promulgated by the China Bank and Insurance Regulatory Committee (CBIRC).

The CBIRC determines whether a parametric insurance product designed by an insurance company is permitted to be sold in China on a case-by-case basis.

As parametric insurance is considered a type of microinsurance product, insurance companies may be reluctant to design and develop parametric insurance products unless the government provides adequate support such as subsidies to policyholders. Therefore, the number of parametric insurance products is relatively limited compared with other insurance products in the market, and potential policyholders do not currently have a wide range of choices available.

Most parametric insurance products in China have an agricultural application and will usually be created from a public-private partnership with participation from local, provincial or city-level governments.

The process is generally as follows: the local government entertains a bidding process on behalf of farmers in a certain region; insurers bid for the business and once these bids are considered and a deal has been concluded between the local government and the insurer, the insurance contracts are written as individual contracts with individual farmers who have chosen to take part in the scheme.

Local governments provide a premium subsidy and policy claim payments are made in a fixed amount to the individual farmers. To summarise, parametric insurance is provided to local individual farmers by local state-owned insurance companies, with subsidised premium negotiated by the government. These are in turn reinsured by either local or international reinsurers.

One example is China’s Ping An (平安) Property & Casualty Insurance Company of China, which offers mobile-enabled parametric insurance protection for farmers against typhoons in eight coastal provinces of China.

The parametric trigger uses data on typhoon paths and wind speeds from the National Meteorological Centre of China. Swiss Re is the technical adviser and reinsurer. Swiss Re also reinsures parametric insurance protection for wind and solar farm operators, triggered by official wind or solar irradiation statistics from an agreed third party.

In another example, GUOYUAN (国元) Agricultural Insurance Co offers weather-based parametric insurance for crab farmers in Anhui province. This parametric insurance product adopts the perceptive technology of the internet of things as well as a weather index model, which simplifies the procedure of loss assessment to some extent.

China offers a conducive jurisdiction for providing parametric insurance cover but currently, because of the lack of specific regulation, these types of products must be approved on a case-by-case basis. There is talk of the regulator introducing a standard set of regulations for parametric products but at present there is not any new regulation that would change the current supervisory framework.

One hurdle for further adoption stems from a lack of financial literacy among the prospective policyholders. Policyholders are mostly farmers and therefore unfamiliar with parametric insurance. Because of this, village committees may assist the farmers in purchasing parametric insurance products.

However, there is a potential that the legitimate rights and interests of policyholders (ie the farmers) may be infringed by unscrupulous village committees. For example, policyholders should usually benefit from government subsidies after purchase, but village committees may not pass on the funds to the farmers.

Mis-selling is also an issue and the CBIRC has found that certain insurance companies offering parametric insurance have misled farmers during the selling process and those companies have been sanctioned by the CBIRC.

In the future, we may see the distribution of parametric agricultural insurance or parametric catastrophe insurance products facilitated through the Shanghai Insurance Exchange (SIE). This was set up by the government for parametric and other agricultural insurance products as a platform through which agricultural insurance can be sold.

For example, a local government looking for bidders to insure the farmers in their region might invite members of the SIE to bid. Chinese domestic insurers would use the same platform to look for reinsurers. In other words, all transactions would be concluded through one platform. The creation of this system is still at an early stage.

*In January, Clyde & Co published the first report in a series on resilience, focusing on parametric insurance. To download the report go to: https://resilience.clydeco.com/articles/closing-protection-gap