The promise and pain of insuring natural disasters at the state level

While claims and compensation for victims are settled expeditiously, the pressures on revenues prevent many states from making top-up contribution to the SDRF and NDRF

Indian States are leaning on insurers to finance their payouts when natural calamities like floods, or drought strike, in an experiment that has been blessed by Irdai.

The experiment has drawn top global re-insurance companies such as Swiss Re to hand hold the states. “Insurance provides the best coverage for infrequent events of high severity that cause significant losses," noted Thomas Haller, Head of South East Asia, Public Sector Solutions, Swiss Re in an email response to Business Standard.

One of the first states to begin this experiment was Nagaland in 2020. Last year, West Bengal and Tamil Nadu also joined. West Bengal has examined such insurance more from the perspective of crop protection for farmers. Results from any of the states are yet to arrive.

The insurance process is as follows: a state buys a cover against a particular natural catastrophe. The underwriters for the risk, (Tata AIG in the case of Nagaland) offer the cover. Other insurers are also planning to enter the market. The reinsurance cover and the technology support is provided by Swiss Re, which is the global leader in appraising the natural catastrophe market. 

If it is a risk against excess rainfall, the reinsurer offers to pay the state if the rains exceed a particular index. As underwriting costs are low, the state does not have to ask the citizens to pay up. So there is no political blowback. Also, the insurance payout of premium ensures that it does not need to draw upon the contingency fund it parks in the State Disaster Response Fund, but can still compensate citizens for losses such as those from the excess rainfall, based on the premium it has paid.

Since insurance claims are settled quicker than money drawn from the state treasury, the compensation for the victims could also be paid out faster. This helps the state government to connect with its citizens in a crisis.

The guidelines for the constitution and administration of the State Disaster Response Fund and the National Disaster Response Fund make it obligatory for the state to put in cash every year, to top them up. The first is the State fund and the surplus is parked in the National Relief Fund.

The Swiss Re institute, which researches on the sector for the company and beyond, has estimated that natural catastrophes in 2021 resulted in economic losses of $270 billion globally, of which less than half, at $111 billion, were insured. Economic losses in Asia Pacific from natural disasters were $78 billion in 2021, an estimate by Aon notes. Within those numbers, India is classified as a highly natural disaster prone area. The classification pushes the cost of reinsurance higher for domestic insurers. Indian insurance companies have tried to mitigate the payment by a system of treaty insurance covers where they pool their premium and coverage, but the global leaders have refused to pick these up, despite agreements with India’s national reinsurer, GIC Re. They prefer to deal one-on-one picking up risks only after the domestic insurance companies bear a large percentage of the initial cover on their own balance sheet.

The choice of Tata AIG by Swiss Re made sense as the former has developed several innovations according to Irdai offerings, for measuring catastrophic risks. These include pay-as-you drive products and the use of drones to assist in catastrophic claims processing. 

Mitigating balance sheet pressures:

Given the pressures on revenues, many states are unable to make the annual contribution to the funds, which is over and above what the central government pays in. So when a natural disaster strikes, the funds aren't available. The states then have to depend on the Central Government-run NDRF. In FY22, the Centre released Rs 17,747.20 crore to 28 states for SDRF. Another Rs 3,543.54 crore was released to seven states from the NDRF. It involves plenty of haggling between the Centre and the states to decide on the compensation sum required.

These are big sums. Even insurers make big payouts. Irdai data shows the total claim made was Rs 3,399.61 crore in FY20. Of these the claims outstanding for natural disasters are Rs 1,705.52 crore . These include insurance claims for super cyclone, Amphan; severe cyclone, Nisarga and so on. 

“As other states recognise the need for more efficient budget allocation, similar discussions are taking place across the country,” Haller noted. But it is taking time. Even the Nagaland cover is not an all-out insurance product but an MoU to help establish the relationship and kickstart the design.

It is backed by an insurance policy as a means to start a collaboration between Tata AIG, Swiss Re and the state, so that a suitable product can be designed for the state. But designing such an innovative product, requires “a bureaucratic leadership keen to innovate”, says Haller. And this can be quite challenge.

While a state will save money, since the premium paid is invariably just a fraction of the possible claim, the leadership will want the national auditor to vet the design before they innovate. Informally, a source in the Comptroller and Auditor General acknowledged it has received queries about the soundness of the legal principles in the insurance approach.

A halfway house, meanwhile, is the InsuResilience Solutions Fund as a public-private partnership project. The concept, floated by Swiss Re, operates like a grant with some support from the company, but Haller said it cannot be extended to other states. “It is not a long-term solution… In the Indian context, insurance protection for increasing resilience to disasters is not a well-adopted concept,” says Haller.

One way to extend the role of such a fund is for the union finance ministry to subsidise some of it. Swiss Re’s Haller claims, “The XV Finance Commission outlines several insurance interventions, and we have been involved in discussions on their operationalisation and implementation.” 

In 2019, Irdai had written to the centre for approval to states to launch such insurance covers. Checks made by Business Standard with the finance ministry shows the proposals have made no progress. Current chairman of Irdai  Debashis Panda has said he wishes to deploy technological tools in a big way in the sector. 

Since some of the states have begun their own experiment, it will be a chance for Panda to evaluate the results. The monsoons, this year, will show whether these are financially better options for state finances.