As climate disasters intensify, India needs a climate insurance market to mitigate economic losses, promote resilience, and drive a green transition
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According to the Global Climate Risk Index 2021, India is the seventh-most vulnerable country to climate change, making it highly susceptible to extreme weather events. While the historical rise in temperatures in India has been slightly lower than the global average, projected increase in the future exceeds global rates. In the absence of adaptation measures, extreme river floods and coastal flooding threaten to affect almost 50 million people by the end of the century. Similarly, in the absence of appropriate mitigation policies, a 3 to 10 percent shrinkage in GDP can be experienced annually due to climate change. The burden of economic stagnation resulting from catastrophes will disproportionately fall on the urban and rural poor. This delineates the need for hedging mechanisms to spread out the climate risk, both geographically and intertemporally.
The burden of economic stagnation resulting from catastrophes will disproportionately fall on the urban and rural poor.
Extreme weather events affect the economy in two stages—the initial damage to human and physical capital, and the subsequent loss of productivity due to efforts directed towards reconstruction. One way to ensure the timely, need-based, and transparent disbursement of reconstruction funds is by roping in dedicated climate insurance. Climate insurance can pay-out claims to insurers in the event of a natural disaster. It can act as a crucial climate adaptation strategy by channelling the excess capital of one agent to compensate for the loss of another, with an additional cost-premium.
The 1990 Intergovernmental Panel for Climate Change report was the first to note the importance of the role of private insurance players in mitigating climate-induced natural disasters. Climate insurance has the potential to enhance both mitigation and adaptation. For instance, insurance companies have the resource-capacity to make long-term investments in disaster-resilient projects, allowing for adaptation. However, when premium becomes a function of the environmental cost of a business’s operations, insurers can influence industry practices. Lower premium and higher coverage for enterprises with a lower carbon footprint can lead the market towards mitigation endeavours.
Lower premium and higher coverage for enterprises with a lower carbon footprint can lead the market towards mitigation endeavours.
The nature of insurance market intervention can acquire two forms. First, the insurance market can incorporate a climate-risk assessment component in all the insurance-policies, facilitating flow of funds to green businesses. Second, the private insurance market can play a more proactive role in rolling out climate risk-insurance policies for sovereign entities like municipalities, state, and national governments to recover from natural disasters. Thus, the market not only serves as a hedging mechanism but also provides a metric of sustainability of businesses through differentiated premium costs.
In India, some of the most climatically-vulnerable and hardest-hit areas are also the poorest. Communities living in coastal areas and hills belong to one of the most economically compromised and climatically-exposed social groups in India. For instance, Indians lost over US$ 3 billion worth of assets due to floods, which amounts to 10 percent of all the global economic loss due to natural disasters. The recovery process to recuperate from the damages is often slow and ill-funded, bedevilled with red-tapeism and whimsical fund disbursement, making it a fertile ground for federal and state government conflicts. Studies show that early intervention can have 3.5 times the impact of delayed payments. In this backdrop, the deployment of climate risk-insurance can provide for a secure and certain source of reconstruction funds to minimise the post-disaster consequences. It can roll pay-outs to the government administration of the affected areas, while also conducting the pre-requisite checks and scrutinies to ensure that funds meet their ends.
The only sub-segment of climate-insurance that India’s insurance market rolls-out is agricultural crop insurance. With 65 crore farmers, most of whom rely on monsoon, vulnerable to unseasonal rains and pest attacks, strategically promoting and effectively implementing crop-insurance can have a huge impact on their livelihoods and well-being. Over 55 million Indian farmers have crop-insurance under the Pradhan Mantri Fasal Bima Yojana (PMSBY). Nearly 70 lakh farmers have benefited from it, in the financial year 2021 with claims worth INR. 87.4 billion (US$ 1.2 billion) transferred to the beneficiaries. Under the interim budget of 2024-24, the PM Kisan Samman Yojana provided crop insurance for over 4 crore farmers.
The only sub-segment of climate-insurance that India’s insurance market rolls-out is agricultural crop insurance.
Another financial instrument to protect farmers against adverse weather conditions is the weather-indexed insurance policy. It is drawn from the weather-risk index, which is based on historical data of weather patterns. This can be a fiscally prudent and sustainable alternative to compensate for evaluated crop-yield loss due to weather-deviation, rather than crop damage. Unlike traditional insurance, this method eliminates the need for extensive loss assessment and quantification, resulting in lower administrative costs and potentially reduced premiums.
Parametric insurance, which like indexed insurance policies, is paid out immediately when a predefined set of parameters is met, is being experimented by the state and central governments. The . In Kerala, the state’s Co-operative Milk Marketing Federation, has also introduced parametric insurance against heat stress. Country-wide parametric policies, directly linking the beneficiary accounts to the insurer, can expedite the pay-out process and limit the economic costs in the aftermath of any climate disaster.
Beyond the traditional crop insurance segment, the Indian insurance market should diversify into other segments too. For low-income individuals and households, micro-level insurance can be useful to secure diverse risks, in exchange for a small payment of premium. These can cover for death and diseases, loss of small-scale assets, livestock, etc caused due to climate-change-induced natural disasters. National or regional governments and large entities can be covered at the macro-level under the sovereign insurance. Sovereign insurance is a financial strategy governments use to manage large-scale risks.
For low-income individuals and households, micro-level insurance can be useful to secure diverse risks, in exchange for a small payment of premium.
In addition to climate insurance, there is need for other risk-hedging mechanisms such as natural resource derivatives, which allow the contract buyers to safeguard their positions in the physical markets. Ghosh (2022) made the case for a water futures exchange in India, given its acute water-availability risk. A water availability index is proposed to compensate for the absence of a physical water market in India. Any stakeholder can hedge their future position by holding an opposite stance in the futures market, insuring themselves against possible risks, given that basis risk is limited. This would serve the same purpose as an insurance policy, but liquid markets would enable faster settlement via immediate squaring-off of positions.
Climate risk insurance can indirectly promote resilient investment by the insurer. Assessing any project or venture for its riskiness, the insurance company can charge higher premiums for projects that do not adopt sustainable and climate-risk adaptable strategies. This will accelerate the adoption of greener, sustainable, and climate-conscious methods. The creation of a climate insurance market in India, with appropriate regulation, can reduce asymmetries, lower transaction costs, and facilitate a green transition through differentiated premium costs. This will eventually create a market signalling mechanism where sustainable practices receive higher preference from investors. Continuous public-private collaboration, aggressive research and development, and financial innovation will be the keys to an efficient climate risk hedging mechanism.
Arya Roy Bardhan is a Research Assistant at the Observer Research Foundation
Lavanya Balasubramani is a Research Intern at the Observer Research Foundation
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Arya Roy Bardhan is a Research Assistant at the Centre for New Economic Diplomacy, Observer Research Foundation. His research interests lie in the fields of ...
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Lavanya Balasubramani is a Research Intern at the Observer Research Foundation ...
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