Closing the Protection Gap: Parametric and the Regulators Encouraging it

Parametric insurance, also known as index-based insurance, pays out claims based on predefined parameters. Common examples include rainfall levels, peak windspeeds and soil moisture. 

This type of insurance could be used to help close protection gaps across the world – with regulators playing an important role in its growth. 

Why Parametric? 

Although the origins of parametric insurance in its modern form can be traced back to the 1990s, it has gained prominence in recent years as interest in innovation and alternative risk transfer has grown. In countries and industries particularly vulnerable to climate risks, parametric insurance is expected to play a crucial role over the coming years. 

In economically developing nations where large protection gaps exist, parametric insurance has the potential to bridge that gap. In Africa, for example, it is estimated that less than 3% of smallholder farmers are insured, compared to 20% in other developing nations. It’s almost universally accepted that natural disasters will increase in frequency and severity in the coming decades, stressing the need for adequate insurance solutions for those currently uninsured. 

Adequate insurance solutions mean efficient claims payouts, tailored coverage and affordable premiums – all of which a parametric policy can provide. Due to these advantages over traditional policies, parametric insurance could be part of the answer if governments and regulators choose to embrace it. 

The Role of the Regulator 

The struggle that many markets are facing is outdated insurance legislation crying out for modernisation. Insurance law, for the most part, is based on the principle of indemnity, which means that many markets do not expressly allow parametric insurance. 

However, more and more countries are starting to develop regulatory frameworks to encourage parametric insurance. The industry regulator for Zimbabwe and the International Finance Corporation (IFC) have launched a parametric insurance project to protect smallholder farmers in Zimbabwe from climate-related crop losses. 

Whilst some insurers are already offering parametric products to farmers in the country, there is currently no regulatory structure approved by the Insurance and Pensions Commission (IPEC). The organisation is working on a framework to guide the industry on these arrangements, aiming to grow the market whilst protecting the needs of insurers and policyholders. 

The project follows in the footsteps of similar successful initiatives undertaken in Kenya and Uganda, suggesting Zimbabwe won’t be the last country in the region to explore parametric insurance as a solution. 

Chile, a nation similarly vulnerable to climate risks, is another country where the regulator is actively promoting parametric insurance. The country’s Fintech Law came into effect in 2023, explicitly allowing parametric insurance. The Financial Market Commission (CMF) is tasked with establishing the criteria and intricacies for such arrangements, which it proposed through its September 2024 draft regulation. 

What Next for Parametric Insurance? 

Effective regulation can foster trust and eliminate uncertainty surrounding non-traditional insurance products. This makes regulatory oversight a key tool in encouraging greater adoption of parametric policies. 

Explicitly allowing parametric insurance also removes the need for regulatory workarounds. In certain jurisdictions, insurers currently work with regulators to create arrangements that ensure compliance. The removal of this barrier should increase the use of parametric insurance. 

With the parametric insurance market anticipated to grow significantly over the next decade, a rise in regulatory measures is likely but also necessary. Although the need for new types of products to close protection gaps is a key driver of parametric insurance, regulators will play an important role in enabling the market’s growth.