Basis risk an issue, but parametric drought risk transfer to expand: Survey

Quality and availability of data is seen as vitally important by insurance and reinsurance market players interested in covering drought related risks, as they seek to reduce basis risk in offerings, a survey from VanderSat has found.

Dutch satellite technology firm VanderSat teamed up with AgroInsurance, an agricultural insurance industry
knowledge hub, to poll the industry on its views on covering drought related risks and to ask what could help to make drought insurance more widely available.

As ever, market’s want to know that their capacity is covering a risk that is well understood, quantifiable and has plenty of data behind it to help them in their analysis of it.

With drought risks, the quality of data is improving all the time, not least with initiatives such as VanderSat’s own satellite monitoring services, that provide microwave data collected from satellites to deliver data on soil moisture and other factors related to drought, as well as to growing.

Survey respondents highlighted data availability and quality as one of the biggest issues that need to be overcome, to encourage them to deploy more capacity into drought risks.

As ever, given drought risk transfer, insurance and reinsurance are often structured using index or parametric triggers, basis risk was raised as something that more granular and abundant data can help to overcome.

Survey respondents said that satellite data is their preferred method to measure drought risk, followed by physical in-field measurement or assessment tools.

While indices based on ground weather stations is currently the most widely used trigger, VanderSat expects this to shift to more flexible sources of remote sensing, such as satellite monitoring, through services like its own.

Interest is particularly high to provide parametric insurance coverage based on soil moisture, an already accepted trigger input.

Over the years, there has been a wide variety of parametric triggers used to transfer drought risks through insurance and derivative deals, while reinsurance is more typically a bundled product with drought included along with other agricultural perils it seems.

But as data availability increases and data provision becomes more technology driven, we expect that discreet drought-only covers will become more widely the norm.

Once basis risk reduces it tends to make perils much more readily insured and reinsured, or indeed hedged, so the fact the industry focused on agricultural drought risks is looking to parametric triggers, satellite data and highly calibrated triggers bodes well for the future of this segment of the industry.

Which also bodes well for more drought risk becoming available to providers of third-party reinsurance capital and any ILS funds that look to allocate and invest capital in these kinds of natural perils.

You can read more about VanderSat’s survey here.