A new study authored by Hang Gao, et al published in The Geneva Papers on Risk and Insurance has highlighted how basis risk is a manageable and structural feature of parametric triggers, decoupling it from financial impacts on insurers or policyholders to focus on its fundamental properties.
According to the paper, weather parametric insurance has become an essential instrument for alleviating climate-related risks, providing more efficient claims processes, diminished moral hazard, and enhanced transparency in comparison to conventional indemnity-based coverage.
Nevertheless, market penetration continues to be limited by intrinsic basis risk, which refers to the discrepancy between index-triggered payouts and actual losses, resulting in either uncompensated losses (Type 2) or unjustified payouts (Type 1).
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