Page 108 - India Insurance Report 2023- BIMTECH

96 India Insurance Report - Series II

events. Various global (re)insurers have formed a partnership under the UN Environment’s Finance
Initiative to develop cutting-edge risk assessment tools to identify the physical and transition risks likely
to impact their balance sheets. These tools are expected to use forward-looking climate scenarios leveraging
the climate science expertise of (re)insurers aligned with the guidelines and recommendations of the
Task Force on Climate-related Financial Disclosures (TCFD).

Stress tests are increasingly being adopted by (re)insurers to assess the impact of climate risks on
their business and operations, which include physical risks, transition risks and liability risks across both
assets and liabilities. In the stress test, the (re)insurers are considering all major potential macroeconomic
scenarios and incorporate all the major physical climate risks to assess the impact of such scenarios on
the portfolio. While stress tests are gold standards for the assessment of exposures to physical risks for
(re)insurers as they assess the impacts of specific shock events, quantifying transition risks is extremely
challenging. Such shock events may bring drastic policy changes and changes in regulatory requirements.
Therefore, quantifying the financial impacts of such scenarios on the underwriting and investment
portfolios is often assessed with proxy variables.

Section 2 : Risk Transfer and Financial Protection

One of the core functions of (re)insurers is to transfer risk from policyholders to themselves through
insurance policies and reinsurance contracts. This helps individuals, businesses, and governments to
manage the financial impacts of climate-related events. By pooling and diversifying risks across a large
portfolio of policies, (re)insurers can provide much-needed financial protection against the increasing
frequency and severity of climate-related losses. This enables policyholders to recover from the losses
and rebuild after a climate-related event, thereby reducing the economic burden on affected communities
and promoting resilience.

With the increasing frequency and severity of natural catastrophic events, fiscal risks are increasing
significantly for various countries. Even though there has been a clear focus on disaster risk management
by the governments, they remain volatile because of the economic shocks created by natural catastrophic
events. Reinsurers are playing a vital role in creating disaster risk financing and supporting countries to
structure customised financial protection strategies that increase the resiliency of governments, industries
and low-income populations.

Parametric insurance and weather derivatives have also been introduced by reinsurers as an alternate
risk transfer mechanism for climate related risks with the increasing pressure on traditional reinsurance
capacities for natural catastrophic risks. Weather derivative takes the form of forward contracts or options
and its value is decided by a climatic index e.g. temperature or rainfall and are being used in the jurisdictions
where such products are allowed by regulators. A weather derivative allows an organisation to protect
itself against adverse weather, and the pay-out is based on a parametric weather index e.g. a gas distribution
company ends up selling sell less gas if the winter is mild, which will impact its revenues. Parametric
insurance products are index-based solutions, and a pre-agreed pay-out is provided by reinsurers if the
mutually agreed climatic index is breached. Low moral hazard and efficient claim pay-out is making
parametric insurance the most sought-after alternate risk transfer mechanism for climate-related risks.