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How is parametric insurance helping to mitigate risks?
Agriculture can be a precarious business, with potential risks including those concerning production, natural resources, financial, marketing and price.
Each holds within it a diverse set of challenges ranging from wildfires and locusts, to cost inflation on key inputs, to commodity price collapse due to a particularly strong harvest halfway around the world.
To make a go of it, growers must face these risks head on, investing hundreds of thousands of dollars or more into seed, fertilizer, labor, and herbicides and hoping for rain – but not too much rain. It is a capital-intensive business where you do not know what the outcome will be until long after the various inputs have been firmly planted into the ground.
Because of this daunting combination of uncertainty and an irrevocable commitment of land, capital, and time on the front end, crop insurance plays a vital role in helping mitigate and de-concentrate this risk to all involved – grower, lender, insurer and government.
Of these numerous risks, production risk is most likely to be insurable. Key factors include adverse climate conditions (for example, drought, excessive rain, flood, windstorm, frost, hail, sunburn, snow), pest and disease attack, and fire. Each of these has the potential to expose not just the farmer but also the insurer to unanticipated, highly correlated impacts at a vast scale.
As Earth's climate changes, the impacts of extreme weather mount across the planet. We are more likely to experience more extreme weather and climate events, including record heat and rainfall resulting in hotter, longer heat waves and heat domes, longer droughts, more propensity to experience wildfires, and extreme flooding and landslides.
According to the World Meteorological Organization, extreme weather, climate and water-related events caused 11,778 reported disasters between 1970 and 2021, with just over two million deaths and US $4.3 trillion in economic losses.1
The impact of climate change on the insurance industry is profound. According to the Environmental Working Group Crop insurance payouts were over $118.7 billion between 2001 and 2022 for the top five weather-related losses in the US alone.2 The National Oceanic and Atmospheric Administration recently reported that July 2024 was the warmest on record and was the globe’s 14th month in a row of record warmth.3
The ability to predict, quantify, and financialize risk is the core competency in this industry. However, the increasingly chaotic risk profile and acceleration of outsized climate impacts are spurring private insurers around the world to not simply raise premiums, but to limit coverage or withdraw outright from a growing number of areas.
While these reductions of exposure for the private insurers may provide a short-term solution for the insurers themselves, insurance industry leaders are increasingly advocating for a more robust government response that makes the continued coverage of farmers on the front lines possible in this rapidly changing risk situation. These trends appear to be here to stay, and the continued provision of traditional crop insurance as it has historically been provided involves significant challenges for all parties, including governments that often serve as an ultimate backstop for large losses. In the US alone, tax dollars cover about 60% of the insurance premiums that farmers pay.4
In the face of climate change and an increasingly dynamic global risk profile, agtech insurance has begun to shift to a new fundamental framework and strategy: parametric insurance. This approach addresses the gaps that traditional indemnity products are struggling to address, and takes on challenges of a scale and breadth beyond which traditional insurance was designed to address.
Figure 1: Insurance based on independent parameter, metrics and indexes
The parametric insurance approach to agricultural risk management can help farmers recover from losses more quickly and affordably, while also mitigating risk for insurers and policy holders alike. Unlike traditional insurance, which relies on assessing individual losses, typically with individual loss adjusters on the ground at any given impacted site, parametric insurance pays out predetermined amounts based on specific triggers, such as weather conditions or indices related to crop performance.
As climate change drives more frequent and severe weather events, parametric insurance provides a lifeline by responding swiftly to droughts, floods, and storms. It ensures farmers are compensated almost immediately, reducing downtime and loss.
To achieve the scale, consistency, and frequency of data underlying such an approach, parametric insurance utilizes Earth Observation (EO) and Geospatial Analytics. These technologies play a critical role in informing how these indices are formulated, managed, and operationally executed against, doing so in a manner that on-the-ground loss adjusters would struggle to replicate.
By eliminating intermediaries and reducing overheads, parametric insurance offers an affordable and accessible safety net. It also promotes long-term sustainability by incentivizing climate-resilient farming practices, with potential premium reductions for sustainable actions.
EO provides objective, large-scale data on crop conditions and environmental factors, which are used to trigger payouts based on measurable indices like vegetation health, soil moisture, or rainfall. This effectively allows insurance companies to assess risks and make claims decisions quickly and accurately without the need for individual field assessments.
Specific examples including excess of rain, carbon index, pasture index, drought index, normalized difference vegetation index (NDVI), and crop emergence index inform parametric indexes or thresholds for trigger payment of validated claims.
Geospatial analytics help to identify crucial drought and flood indicators in vegetation health, soil moisture, soil erosion and reservoir water levels. Insights from satellite data can inform models to automatically identify a given regions potential impact from hurricanes or typhoons. EO can help assess the extent and impact of landslides or debris flows.
Food production is essential to human existence and providing the right incentives and risk mitigation tactics to sustain a robust food production capacity is more important now than ever. By harnessing the power of EO data and deploying it into the scalable, quantifiable, and responsive execution of parametric insurance, innovative insurers are tackling the emerging challenges of climate change head on and transforming the ag insurance industry to create a more resilient and food-secure future for all.
These innovations are not just incremental improvements – they are revolutionizing the agricultural landscape. By providing smallholder farmers with access to financial products tailored to their specific needs and integrating cutting-edge technology, Ag-FinTech is driving a new era of productivity, sustainability, and economic empowerment in agriculture. The future of farming is not just digital – it's transformative.
Incorporating climate change into the heart of Agri-FinTech innovation is not just a necessity – it's an opportunity. By developing financial products and leveraging technologies that address both immediate and long-term climate risks, we can build a more resilient, sustainable, and inclusive agricultural sector.
Farmers are no longer just growers; they are becoming climate-smart entrepreneurs, equipped with the tools and insights to thrive in a rapidly changing world.
Author: Andrew Mullin, Vice President Marketing at Earth Daily
References
1. World Meteorological Organization. Economic costs of weather-related disasters soars but early warnings save lives.
2. EWG. EWG: Extreme weather linked to climate crisis triggered $118.7B in crop insurance payments.
3. National Oceanic and Atmospheric Administration. Earth just had its warmest July on record.
4. Tax Payer for common sense. Record Taxpayer Costs of Federal Crop Insurance Program.
