Droughts, floods and pandemic illustrate the protection dividend from parametric insurance solutions

Droughts, floods and pandemic illustrate the protection dividend from parametric insurance solutions

Drought in the Horn of Africa during 2021 and 2022 and severe flooding in South Africa (in April 2022) and Nigeria (in October 2022) illustrate the impact of natural catastrophes on lives and livelihoods across the African continent. These high impact events also shine the spotlight on the insurance gap that afflicts developing countries, with the economic losses following such events far exceeding the insurance pay-outs.

“The most recent studies estimate the protection gap following drought and flood disasters on the continent to be as high as 97%, which is quite staggering,” said Malvern Chirume, chief underwriting officer at African Risk Capacity Ltd (ARC Ltd).

Countries that are afflicted by drought and flood are increasingly turning to parametric insurance solutions as a means to offer a basic level of protection against drought and flood, for the most vulnerable in society. These products, which are typically bought by governments and / or NGOs, are designed to cover against specific loss events within strictly defined geographic areas. The big differentiator between parametric insurance and general insurance covers is that there is no need for loss adjusting or assessing post-event; the policy pays-out the moment certain measurable triggers are breached. So, for example, in the case of drought cover, the parametric insurance would automatically pay out if rainfall in an insured area was too low.

ARC Ltd, which has been underwriting drought-related parametric insurance solutions in Africa for a number of years, is making final preparations for its flood and ‘outbreaks and epidemics’ products, with the former launching in late 2022 and the latter scheduled for the first half of 2023. “We have just completed the final stages of quality control on our flood solution, assisted by both internal and external experts in the parametric insurance field,” said Mr Chirume. Governments in select countries will soon be able to structure needs-appropriate cover for three major risks, including drought, flood and outbreaks of disease.

Developing sustainable parametric solutions presents numerous challenges. “The availability of accurate, comprehensive and multi-year weather data is a major challenge when developing and underwriting weather-based parametric insurance products for the African continent,” said Mr Chirume. Insurers underwriting weather risks in Africa have to make the best of the available data, whereas those developing products for hurricanes and storms in the Caribbean or along the US’ Atlantic seaboard have no shortage of data and risk models to base their risk exposures and pricing off.

Africa-focused weather monitoring capabilities are growing exponentially, with more satellites in orbit around the globe than at any time in history; but the issue is less with the detail of the coverage than it is with the duration of coverage, or historic data. “For an insurer to accurately issue and underwrite a parametric product requires a lengthy history, so while we welcome the positive developments in terms of seeing new satellites and new Earth observation equipment, we do need longer time series to ensure better outcomes,” Mr Chirume explained. In the interim, the best that underwriters can do is to use other risk assessment techniques to reinforce what little data is available.

2022 has been a difficult year for both insurers and reinsurers due to an ongoing increase in extreme weather events globally, and the already mentioned drought and flood events across Africa. As a consequence, global reinsurance markets are going through a hard cycle. Reinsurers are being specific about the risks that they select and the pricing they offer and are responding to uncertainty through a combination of higher risk premiums, restrictions on sums insured, or simply refusing cover outright. According to Chirume, ARC has experienced a significant dislocation of the reinsurance markets throughout 2022, and the insurer expects the coming year to be incredibly difficult in terms of its ability to place reinsurance at an acceptable price, and for the type of coverage required.

Hard reinsurance cycles bring pressure to bear on insurers, insurance brokers and their end clients, whether these clients be businesses, individual insureds, NGOs or sovereigns. Despite these challenges, ARC has managed to bring its flood solution to market well within expected timelines. “Flood is notoriously difficult to cover, especially when you consider urban flooding; in Africa we see a lot of settlements being built too close to rivers and often in areas that are not condoned by local government,” Chirume said. There are also various manmade factors like ineffective drainage, poor infrastructure and rapid urbanisation that make flood risks difficult to model.

The development of accurate models of on-the-ground risk exposures are non-negotiable when developing parametric risk solutions. Given the aforementioned factors, it is often easier to model flood exposures based on a so-called river line coverage scenario than an urban area spanning many square kilometres. This type of solution, which would typically cover structures within certain channels on either side of a river line, remains the best way to help the most vulnerable in society – or governments on their behalf – to plug the insurance gap.

“There are many people who do not have access to risk management and insurance protection, and we believe that raising awareness of this problem should be a priority – we must spread the word that there is something that governments can do to plug this protection gap and reduce the financial stresses if / when disaster strikes,” said Chirume. “We stand ready to be part of the solution for those governments that are keen to pursue this path”. This pledge was made alongside three wishes for the parametric insurance sector through 2023.

The first wish is for insurers to make a significant dent in the protection gap that exists on the African continent. “The only way to fill this gap is to get more countries into the risk pools – we will have more products available in the coming year, and it is our hope that we can scale up rapidly, especially from a flood and ‘outbreaks and epidemics’ perspective; growth and diversification will help Africa to succeed as an insured pool,” he said. The second wish is to advocate for better risk management practices within the public sector. This requires decision makers within governments’ social departments to appreciate the power of parametric insurance in protecting the lives and livelihoods of citizens.

And finally, the third wish to bring it all together. “As insurer, we must find ways to protect our own balance sheet over the long-term using more predictable mechanisms,” concluded Chirume. “Reinsurance is generally predictable, but given the hardening cycle through 2022, which is expected to persist through 2023, insurers will have to explore alternative ways to protect our balance sheets and offer our life-changing risk protection solutions on a sustainable footing”.

For the full Drought case study, click here


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