Regional Index Insurance Using Satellite‐Based Fractional Flooded Area

Abstract

Abstract Emerging parametric insurance products targeted at regional governments consider an index of flooding as the instrument for payoff and rate setting. Inundation extent from satellite remote sensing may provide a more direct measure of flood risk in this context than hydraulic modeling of flow and inundation. Here, we examine satellite‐based fractional inundated area as a proxy for flood impact that can be used for index insurance payment at a regional scale. Typical methods for estimating return periods from unbounded distributions such as the Generalized Extreme Value distribution are not appropriate for fractional flooded area, which is bounded by 0 and 1. Here we examine alternative bounded distributions (2 parameter and a 4 parameter Beta) to estimate return periods and quantify uncertainty using a bootstrap sampling procedure for the short duration satellite record of fractional flooded area. We consider two examples with distinct flood dynamics (a) a country (Bangladesh) where a flood can cover the majority of the land surface, and (b) a river basin (the Rio Salado basin in Argentina) where the worst flood covered only a modest fraction of the watershed. We explore how a parametric insurance policy based on fractional flooded area could be priced based on a typical approach used in the industry, that accounts for uncertainty for small sample estimation. Our exploratory approach to model selection illustrates how estimating the uncertainty price influences insurance contract pricing and is important to consider the choice of distribution beyond just the traditional measures of goodness of fit.

Keywords

• inundation
• insurance
• remote sensing
• probability
• risk transfer
• flooding