Index-based insurance to mitigate current and future extreme events financial losses for water utilities

Abstract

Mitigation and management strategies for extreme weather events become increasingly important for the development and maintenance of society as these events become more frequent and intense. Drought and flood management strategies have focused on structural measures; however, they are not sufficient to prevent water supply disruptions and economic losses. In this concept, adaptation plays the role of anticipating the adverse financial impacts of extreme weather events and taking appropriate measures to minimize them. Therefore, insurance is a valuable adaptation tool to offset unexpected losses and prevent financial damage from turning into long-term economic damage. We simulated multi-year and multi-risk index-based insurance for a Water Supply System, responsible for providing water to 7.2 million people. Our methodology comprises (1) characterizing the indexed variable, (2) calculating economic losses by Loss Distribution Approach (LDA) for current and future periods, and (3) estimating risk premiums based on expected losses of the low, medium, and high coverage levels. Our findings indicate a linear relationship between premium and coverage level, i.e, the higher the premium, the higher the insurance coverage level. We suggested a premium fee for each evaluated scenario, which would be introduced into the water bill as a novel way to pool risk among customers and protect them from surcharge fluctuations.