Introducing index-based insurance in South Africa : feasibility of implementation within the current Insurance Legislative Framework

Abstract

The financial sector has seen many innovations in financial technology (fintech) and the insurance industry has not been immune to innovation. Fintech promotes competition and innovation, allows for lower transaction costs, and increases access to financial services. This in turn promotes financial inclusion for the excluded and underserved.

Index-based insurance, also referred to as "parametric insurance", is an innovative approach to insurance, which is still in its infancy in South Africa. The first index-based insurance products were developed in the 1920s by Indian economist JS Chakravarti. Index-based insurance is based on contracts that use a pre-determined index for claims. The policyholder is entitled to the policy benefits when the index is triggered, irrespective of whether they had suffered an actual loss, lodged a claim or had the damage assessed. This often results in basis risk, in terms of which there is a misalignment between the loss incurred and the policy benefits of the policyholder. Index-based insurance is intended for large-volume, low-value insurance contracts, for example, for small-scale farmers. Under index-based insurance contracts, a policyholder might incur loss and yet not be indemnified for the loss because the index was not triggered. In contrast, a policyholder might be "indemnified" without incurring any loss due to the index being triggered. To this extent, this study sets out to understand the intrinsic features of index-based insurance and the challenges in the context of the current legislative and regulatory framework. This study intends to make a compelling case for allowing index-based insurance products in South Africa, drawing on Kenya's experience and research from relevant international organisations. The surveys conducted by A2ii will serve as a foundation for the challenges that need to be addressed by South Africa.