# EUR-Lex - 52013DC0213 - EN

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# 52013DC0213

**GREEN PAPER on the insurance of natural and man-made disasters /* COM/2013/0213 final */**

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GREEN PAPER

on the insurance of natural and man-made
disasters

1.           Introduction

As many other regions of the world, the
European Union is vulnerable to nearly all types of natural disasters.
Disasters not only cause human losses but also damages to the value of billions
of euros every year, affecting economic stability and growth. Disasters may
have cross-border effects and can potentially threaten entire areas in
neighbouring countries. Even where costs of major disasters are locally
concentrated, if costs are inadequately covered by insurance then individual Member
States may carry large fiscal burdens, which could cause internal and external
imbalances. This is thus an important issue for citizens, companies and
governments across the Union.

In 2010 the Council invited the Commission
to evaluate and report on the potential for the European Union to facilitate
and support increased coverage of appropriate disaster risk insurance and
financial risk transfer markets, as well as regional insurance pooling, in
terms of knowledge transfer, cooperation, or seed financing[1]. Subsequently, the Commission
organised a Conference on prevention and insurance of natural catastrophes[2] and conducted a study entitled
"Natural Catastrophes: Risk Relevance and Insurance Coverage in the
European Union"[3].

This Green Paper poses a number of
questions concerning the adequacy and availability of appropriate disaster
insurance and accompanies the Communication entitled "An EU strategy on
adaptation to climate change". The objective is to raise awareness and to
assess whether or not action at EU level could be appropriate or warranted to
improve the market for disaster insurance in the European Union. More
generally, this process will also expand the knowledge base, help to promote insurance as a tool of disaster
management and thus contribute to a shift towards a general culture of disaster
risk prevention and mitigation, and bring in further data and information.

The following graphs provide an overview of
the occurrence of natural and man-made disasters in the European Union during
recent years.

Graph 1: Natural disasters in EEA States
(1980–2011)

Source: European Environment Agency, Climate
change, impacts and vulnerability in Europe 2012, An indicator-based report, EEA
Report No 12/2012.

Storm surges, river or flash floods are one
of the main natural disaster risks facing Europe (e.g., the 2012 United Kingdom, Ireland and Romanian floods, 2002, 2005 and 2010 Europe-wide floods).

Graph 2: Floods – maximum historical
losses

Source: Joint Research Centre, European Commission
(2012), Natural Catastrophes: Risk relevance and Insurance Coverage in the
EU, based on available data[4].

Wild forest fires are also a threat that Member
States have to deal with every year. The 2003 heat wave was the hottest on
record in Europe since at least 1500[5].

A number of winter and wind storms have
also caused severe damage in European countries in recent years.

Graph 3: Storms – maximum historical
losses

Source: Joint Research Centre, European Commission
(2012), Natural Catastrophes: Risk relevance and Insurance Coverage in the
EU, based on available data.

The 2009 L‘Aquila and the 2012 Emilia
Romagna earthquakes resulted in deaths, injuries and devastation of residential
and commercial property. Earthquakes can also trigger tsunamis in Europe (such
as in 1908 in Messina or in 1755 in Lisbon).

Graph 4: Earthquake – maximum historical
losses

Source: Joint Research Centre, European Commission
(2012), Natural Catastrophes: Risk relevance and Insurance Coverage in the
EU, based on available data.

The volcanic eruption of Eyjafjallajökull
in March 2010 demonstrated how far-reaching the consequences of a natural
disaster can be. Experience has shown that such an improbable event may have
long-lasting and serious consequences for other parts of Europe and of the world.

Between 1980 and 2011, the economic toll of
natural disasters in the whole of Europe approached 445 billion euro in 2011
values. About half of all losses can be attributed to a few large events, such
as storms like Lothar in 1999, Kyrill in 2007 and Xynthia in 2010, and to the
floods in central Europe in 2002 and in the United Kingdom in 2007. Damage
costs from extreme weather events in EEA States have increased from EUR 9
billion in the 1980s to more than 13 billion euro in the 2000s (values adjusted
to 2011 inflation)[6].

Graph 5: Natural disasters in EEA States
– loss events, fatalities and losses (1980 to 2011)

Source: European Environment Agency, Climate
change, impacts and vulnerability in Europe 2012, An indicator-based report, EEA
Report No 12/2012.

With climate change, insurance will be
called upon to cover increasingly frequent and intense events. Changes in
climate, demographics and population concentrations, growth in catastrophe-exposed
areas and rising wealth and property values are increasing the exposure and
vulnerability of economic assets and the severity of losses[7]. In the short term, the effect
of climate change on insurance may not be that significant. However, in the
longer term, particularly in sectors or areas where insurance has not been
customary, climate change could have an impact on the availability and
affordability of insurance. Potential losses are highly dependent on changes in
exposure and vulnerability. Overall, the probability of most types of extreme
weather events is expected to grow significantly[8].
As a result of increasing risks, insurance might become unavailable or
unaffordable in certain areas. Unavailable insurance, one of the factors that
contributes to vulnerability, may exacerbate the susceptibility of society,
leaving governments with potentially large financial exposures.

Man-made disasters, such as industrial
accidents involving dangerous substances can also have large-scale and
cross-border impacts (i.e., the 2010 Gulf of Mexico accident related to
offshore oil extraction, the 2011 alumina depot leaks in Ajka, Hungary). Furthermore, natural hazards and disasters, for example, lightning, low temperature or
earthquakes, may trigger man-made (‘natech’ - Natural Hazard Triggering
Technological Disasters) disasters such as atmospheric releases, liquid spills
or fires[9]
(i.e., the 2011 Fukushima nuclear disaster, Japan). Such compound ‘natech’
disasters can occur more often due to the increased frequency of extreme
natural events and the increased complexity and interdependency of industrial
systems.

Graph 6: Industrial accidents in EEA
States reported in the Major Accident Reporting System

Source: European Environment Agency, Mapping the impacts
of natural hazards and technological accidents in Europe, EEA Technical Report
No 13/2010.

Private insurance can address a number of
related policy concerns and can contribute to sustainable public finances[10]. Insurance is one of the tools
for disaster risk management, together with risk prevention, preparedness and
response measures: a functioning disaster risk insurance system, beyond risk
sharing, can be operational at all levels of the risk management cycle, from
risk identification and risk modelling to risk transfer and recovery. Insurance
has a specific role: it does not prevent the loss of lives or assets but helps
to reduce the economic impact and facilitates recovery after disasters.
Well-designed insurance policies can also work as a market based instrument to
discourage risky behaviour and promote risk awareness and mainstream disaster
proofing in economic and financial decisions.

2.           Market penetration of
natural disaster insurance

Major natural disasters have large and
significant negative effects on economic activity, both in their intermediate
impact and in the longer term. It is mainly the uninsured losses that drive the
subsequent macroeconomic cost, whereas sufficiently insured events are
insignificant in terms of forgone output[11].

Recent analytical research undertaken by
the Joint Research Centre shows that, based on available data, there is
currently a low market penetration rate of disaster insurance in certain Member
States[12].
The analysis highlights that flood, storm and earthquake risk is, as expected, heterogeneous
among Member States. However, based on available data, there are cases where
disaster insurance markets do not seem to cope fully with existing risks.
According to the research available, for storms, penetration rates are high in
most Member States. However, for flood and earthquake, penetration rates are only
high in cases where those risks are bundled with other risks.

Graph 7: Natural disasters in EEA States
(1980 to 2011) – overall and insured losses

Source: European Environment Agency, Climate
change, impacts and vulnerability in Europe 2012, An indicator-based report, EEA Report No 12/2012.

(1) Questions (1) What is your view on the penetration rate of disaster insurance in the European Union? Please provide details and data to support your arguments. Is more research needed to understand any possible gaps in insurance supply and demand, insurance availability and coverage?

2.1.        Product bundling

Insurance redistributes and reduces the
financial risk associated with adverse events, by sharing costs either between
individuals or over time. Insurance transfers individual risks to a pool,
managed by an insurer. By aggregating or pooling risks, it is possible to
reduce the cost of disasters in any particular time period.

The coverage provided by the private
insurance market is funded through premiums, backed up by shareholder capital
to meet likely deviations from the expected losses. Insurance premiums reflect
the expected loss of the insured individual, an uncertainty margin for the
given line of insurance business, a charge for the shareholder capital, a share
of loading costs, i.e., administrative and other costs associated with
underwriting insurance policies, and profit. The premiums are invested on
financial markets, where the investment risks need to be uncorrelated with the
underwriting risk, or re-insured to take some of the risk out of the pool. In
this way, insurance spreads the risk of economic loss across society and over
regions.

The specific feature of disasters is that
they can damage many properties in a concentrated area at the same time:
earthquakes occur along seismic fault lines, floods occur in low-lying areas
and windstorms are very often directed at coastlines. This contrasts with other
types of risk against which property insurance provides cover, such as theft or
fire. It is unlikely, although not impossible, that an entire neighbourhood is
burgled at the same time.

There are two main techniques to enable
insurance to handle correlated risks. The first is to widen the pool, to make
it very unlikely that individual risks are highly correlated through any
potential disaster. Another common technique is bundling together several types
of uncorrelated perils into a single insurance policy, e.g., fire and flood,
storm or earthquake[13].
Since each peril is independent from any other in the policy, bundling reduces
the accumulated risks of any one hazard in the policy.

Product bundling represents general
solidarity between consumers. Therefore, product bundling is sometimes
introduced through a mandatory extension of simple risks such as fire or motor
insurance to natural disasters coverage. Ideally, the system should recognise
that some insured persons pose no or low risks compared to those from
risk-prone areas, through, for instance, premium discounts.

Questions (2) What further action could be envisaged in this area? Would mandatory product bundling be an appropriate way to increase insurance cover against disaster risks? Are there any less restrictive ways, other than mandatory product bundling, which could constitute an appropriate way to increase insurance coverage against disaster risks?

2.2.        Compulsory disaster
insurance

Consumers may not be inclined to insure
themselves against risks that are unlikely to individually impact on them.
People and businesses often underestimate the real risk of a disaster to them
(risk myopia), and are not properly prepared to deal with the financial
consequences. They rely on social networks or government relief.

Another issue may be that of adverse
selection. This refers to the phenomenon in insurance whereby groups of people
who feel that they are at a higher risk will purchase insurance to a large
extent, whereas those who do not perceive such a high degree of risk will not
feel it is necessary to purchase insurance. Adverse selection is particularly
troublesome in disaster insurance. If only the highly exposed purchase
insurance, the premium will be prohibitively expensive, and the pool will be
too small to cope with disasters, since there is no buffer from unaffected
members of the pool.

Compulsory disaster insurance could
overcome those problems. It results in high market penetration and a large pool
of insured persons. This facilitates risk spreading and reduces administrative
costs per policy, while limiting ex-post government relief.

Questions (3) Which compulsory disaster insurance, if any, exists in Member States? Are these insurance products generally combined with compulsory product bundling or obligation for insurers to provide cover? Is compulsory disaster insurance generally accompanied by a right for the customer to opt out of some disaster risks? What are the advantages/possible drawbacks? Would EU action in this area be useful?

2.3.        Disaster insurance pools

Disaster
insurance pools may extend the risk absorption capacity of the insurance
market. They can provide coverage against aggregate exposures and risks that
are uninsurable because of moral hazard, the small size of the given market or
excessive claims cost. The pools may supplement systems with mandatory product
bundling or with compulsory insurance.

The Commission renewed with modifications
the co(re-)insurance pools exemption in the Insurance Block Exemption
Regulation 267/2010[14].
It recognised that risk sharing for certain types of risks, for which
individual insurance companies are reluctant or unable to insure the entire
risk alone, is crucial in order to ensure that all such risks can be covered.

The Regulation only allows co-operation
through pools under certain conditions. Also, it is limited to agreements which
do not afford the undertakings involved the possibility of eliminating
competition in respect of a substantial part of the products in question. Pools
outside the Regulation due to high market shares are not forbidden, but need to
be self-assessed under competition rules as they may involve benefits so as to
justify an exemption under Article 101(3) of the Treaty on the Functioning of
the European Union.

2.4.        Governments as
(re-)insurers and (re-)insurers of last resort

Public authorities may be involved as
insurers or may sponsor state-mandated catastrophe insurance pools. Such
insurance programmes can alleviate political pressure to allocate substantial
governmental resources in the aftermath of a natural disaster. But the
framework needs to prevent the problem of moral hazard, e.g., policy-holders
might be encouraged to behave in riskier ways once they know that they will be
covered by public resources whether they protect themselves beforehand or not.

Through public-private partnerships,
insurers may offer their expertise and tools (such as risk information
platforms) to assess the risks, sell policies and in some cases advise
governments in their investment decisions. Insurers may also be required to
provide insurance coverage for medium-sized losses; the government limits its
exposure and insurers bear a level of risk that is within their capacity.

Governments may also manage re-insurance
programmes. They can require the private market to take on and pay for some proportion
of the risk, i.e., quota-share treaties.

Governments may serve as (re-)insurers of
last resort by taking on risks above a certain disaster damage level, i.e.,
stop-loss re-insurance. This approach blends the potential risk-spreading
capacity of the government and the ability of the market to apply insurance
principles and also to use its administrative capacity, i.e., collecting
premiums, marketing and handling claims. Public programmes, therefore, may
provide for cover at the highest risk levels, while the private market retains
some or all of the lower tiers of risk.

Questions (4) How can state or state-mandated disaster (re-)insurance programmes be designed and financed to prevent the problem of moral hazard?

2.5.        Parametric index-based
weather insurance and other innovative solutions

2.5.1.     Parametric index-based
weather insurance

Under traditional weather-related insurance
schemes, such as property or liability insurance, insurance compensation will
be paid out following an assessment of the insured party's losses. Once a loss
assessment is completed and agreed, the insured party receives an indemnity
pay-out.

Under a parametric index-based insurance
scheme, losses resulting from extreme weather-related events are compensated
when a pre-defined weather index deviates from the historic average,
irrespective of the actual loss. That type of insurance relies on the
measurement of an objective and independent index that is highly correlated
with the actual loss. Traditional indemnity-based and parametric insurance can
be combined.

Building on lessons and experience from
different regional initiatives[15],
parametric insurance could be considered as a solution both for the private and
public sectors, e.g., for critical public infrastructure. It can improve affordability
of insurance by reducing administrative costs, because it does not include a
claims adjustment process. It also speeds up pay-outs, and can be associated
with simpler insurance contracts. Parametric covers can help reduce information
asymmetries between insurers and customers. On the other hand, such contracts
present a significant basis risk, i.e., the claim pay-out does not match the
actual loss incurred and policy-holders are not necessarily able to assess it.

Insurance is a critical requirement for
development as uninsured losses can extend the cycle of poverty and impede
economic growth. Alternative, simplified risk transfer tools such as
micro-insurance products are being developed in developing countries.
Parametric insurance programmes, supported by the Commission, have also been
implemented in third countries, particularly exposed to weather and
catastrophic risks such as droughts, earthquakes, and storms[16].

2.5.2.     Meteorological research

The complexities of parametric design and
basis risk may be significant constraints on extending these schemes.
Meteorological research needs to identify viable indexes. It can only be
scaled-up for widespread coverage if there is systematic coverage of the
territory, with weather stations sufficiently close to insured persons and risk
zones mapped. In addition to the physical presence of meteorological stations,
there is a need to collect, maintain, share and archive data and to make them
readily available in relation to insured events. The use of satellite data in
combination with numerical analyses and forecasts has already resulted in a
continuous increase in the skills required for making meteorological forecasts.

Similarly, opportunities related to
satellite-based indices that use remote sensing tools can be explored. Many
economic sectors are sensitive to climate conditions, hence to a changing
climate. Therefore, the benefits of investing in weather infrastructure will
extend beyond the development of index-based insurance products, notably to
forestry and agricultural products. The Commission is currently conducting
consultations aimed at the future implementation of a Climate Change Monitoring
service as part of the European Earth monitoring programme (GMES)[17].

2.5.3.     Insurance-linked securities

Insurance-linked securities such as
catastrophe bonds or other alternative risk transfer instruments can be seen as
an effective way of increasing insurance capacity for highly improbable,
low-frequency, high-severity natural catastrophe events.

For insurers, re-insurers and businesses,
the bonds provide multi-year protection against natural catastrophes with
minimal counterparty credit risk. To investors, they offer the potential to
diversify and reduce their portfolio risk as the bond defaults do not correlate
with defaults of most other securities.

Questions (5) Do you see any difficulties, barriers or limitations in using information to generate parametric insurance? Which factors could scale-up the promotion and uptake of such innovative insurance solutions?

3.           Disaster risk awareness,
prevention and mitigation

There is strong political awareness in the
European Union around the need to develop and implement strong Disaster Risk
Management (DRM) policies that aim to build resilience against disasters and
mitigate their most severe effects[18]
both inside the Union and in its external action.

At the international level, resilience and
disaster risk reduction have been featured as a key theme in international
summits such as the Rio Summit on sustainable development in 2012, or the G20
initiatives on disaster risk management and the development of a methodological
framework intended to help governments in developing more effective DRM
strategies and, in particular, financial strategies, building on strengthened
risk assessment and risk financing[19].
Furthermore, the process toward a new international framework for disaster risk
reduction (post-2015 Hyogo Framework for Action) puts an increased focus on the
financing aspects of disaster risk management and the economic costs of
disasters.

Managing risks from natural disasters
requires better management of exposure to natural hazards, through urban and
land-use planning. A disaster management policy needs to encompass prevention,
resilience and reduction of individual vulnerability and strengthening
eco-systems. In hazard-prone areas, property owners will have to invest even
more in property-risk reduction measures.

Disaster risk management can help to
promote undisturbed economic development and prosperity:

·
In the short term, investing in risk management
can be a means of accelerating actions for growth and jobs (new technologies,
research and development, resilient buildings and infrastructure, innovative
financial instruments);

·
In the medium term, improved disaster assessment
and resilience helps to focus on structural sustainability of public and
private finances, and to improve the macro-economic stability by reducing the
detrimental impact of natural and man-made disaster on growth and public and
private budgets.

·
In a long-term perspective, investing in risk
management has a high rate of return and is contributing to sustainable
economic development.

Risk assessment (including analysis of
exposure and vulnerability) is an important and fundamental step in order to inform
disaster risk management and the planning process and in order to allocate
financial resources. Multi-risk assessments taking into account possible
hazards and vulnerability interactions may also help to address correlated
risks and knock-on effects.

Building resilience is a long-term effort
that needs to be integrated in national policies and planning: resilience
strategies are also part of the development process and contribute to different
long-term policies, in particular climate change adaptation and food security.

3.1.        Insurance pricing as an
insurance market-based incentive to promote risk awareness prevention and
mitigation

Governments could continue to absorb a
large share of the costs of mitigation and public relief by continuing to
generously compensate victims. But this is likely to exacerbate governments’
budget difficulties and encourage undesired development in risk-prone areas.
Alternatively, public authorities could withdraw resources from this area,
control development in risk-prone areas and rely more heavily on market forces
to encourage individual responsibility for reducing losses and insuring against
them.

Insurers can provide market-based
incentives for risk prevention. Risk-based pricing can motivate insured persons
to take individual measures to reduce the vulnerability of their property. If
the premium fairly reflects the level of risk, accompanied with
risk-appropriate discounts for insured persons who invest in loss reduction, it
motivates them to take risk reduction measures. However, often the cost of ex-ante
risk reduction for individuals is not economic, compared to simply insuring
against the risk, or taking community-level risk prevention measures. If
insurance premiums reflected the real risks, high risk behaviour would be
prohibitively expensive. The respective roles of the public and private sector
in taking risk prevention action should, therefore, always be considered.

According to established case-law, insurers
enjoy the freedom to set insurance premiums[20].

Risk-based pricing[21] necessitates a sophisticated
underwriting process. It requires a high degree of information and implies
administrative costs for insurers. Risk-based pricing can deter people from
living in risk-prone areas, or necessitate public intervention. Differentiation
of premiums according to risk also involves administrative costs but is likely
to save future claims since the premiums stimulate disaster risk reduction.

Risk-based pricing can, however, penalise
certain high-risk groups. There may be risks that are uninsurable or risks that
would necessitate an increased or unaffordable level of premium.

Private responsibility for disaster risks
may also play a role in providing market incentives for individual
loss-prevention measures and in discouraging development in high-risk areas.
Fundamental issues of equity and social solidarity arise when responsibility is
attributed, especially in poor and vulnerable regions.

Public authorities may decide to impose the
use of community-rated or flat-rate insurance premiums, which result in
cross-subsidisation from people living in low-risk areas. The rating may
increase the relative take-up rate among consumers from risk-prone areas.
However, such rating exacerbates land use externalities: with flat-rate
premiums, insured persons do not pay for the risk they generate by living in
exposed areas. All permitted locations represent the same insurance costs for
households. Combining solidarity with strict building restrictions and
standards partially corrects the imperfect internalisation of risk and
increases efficiency. The insurance rating can also differentiate between risk
zones as a partial recognition of different levels of risk.

Questions (6) Could risk-based pricing motivate consumers and insurers to take risk reduction and management measures? Would the impact of risk-based pricing be different if disaster insurance was mandatory? Do insurers in general adequately adjust premiums following the implementation of risk prevention measures? (7) Are there specific disasters for which flat-rate premiums should be suggested? Should flat-rate premiums be accompanied by caps on pay-outs? (8) What other solutions could be offered to low-income consumers who might otherwise be excluded from disaster insurance products?

3.2.        Long-term disaster
insurance contracts

Natural disaster risks are, in principle,
covered by annual contracts. Annual contracts provide flexibility and choice;
consumers may regularly switch between competing insurers and products.

A long-term insurance contract with transparent
risk-based pricing and premium discounts for risk reduction could strengthen
economic incentives by making investment in risk reduction beneficial to both
contracting parties (insurer and insured). A long-term contract at a guaranteed
price, or a price with pre-defined conditions for price ceilings, or regular
inflation adjustments, could provide financial and contractual certainty for
the insureds. It could also drive down the administrative and transaction costs
for both parties as the contracts would not need to be renegotiated each year.

There may, however, be a greater
uncertainty and ambiguity about the underlying risks. It seems that the annual
insurance premium of a multi-year contract is likely to be greater than the
premium of an equivalent annual contract. Consequently, the capital
requirements and return on capital demanded by investors would also be higher.
On the other hand, under Solvency II, long-term insurance contracts increase
the insurer’s capital because the expected profit over the full term of the
contract is recognised at the outset.

Insurers currently offer long-term life
assurance or health insurance contracts. It is not yet clear, however, whether
property insurance can be long-term whilst providing cover at an affordable
price.

Questions (9) Is there a case for promoting long-term disaster contracts? What would be the advantages/drawbacks for insurers and the insured persons respectively?

3.3.        Pre-contractual and
contractual information requirements

Consumers need
to clearly understand what type of cover they have, how it would operate in the
event of a disaster and that their policy deals with unusual impacts, not
everyday losses. The recent research undertaken by the Joint Research Centre
suggests that consumers do not tend to purchase disaster insurance against
low-probability and high-severity events[22].
The current challenging financial position of many households in several Member
States is also likely to act as a disincentive for the purchase of disaster insurance.

Unlike the Life
Assurance Directive 2002/83/EC[23],
the First, Second and Third Non-life Insurance Directives 73/239/EEC[24], 88/357/EEC,[25] 92/49/EEC[26] do not contain any rules on
pre-contractual and contractual information for policy holders. Neither does
the Solvency II Directive 2009/138/EC[27]
include such rules for non-life insurance risks.

In the non-life
insurance sector, therefore, information requirements on insurers with a view
to protecting consumers vary greatly. It is pivotal to increase consumer
confidence by providing clear rules and eliminating legal uncertainties. An
insurance market with well-informed consumers forces insurers to compete to
attract and retain them. Harmonised pre-contractual and contractual information
requirements would also enhance consumer confidence and encourage the consumer
to purchase safely throughout the whole European Union.

Questions (10) Do you think there is a need to harmonise pre-contractual and contractual information requirements at EU level? If so, should the approach be full or minimum harmonisation? What requirements concerning the commitment should be included, for instance: – the nature of the insured risks, – adaptation and prevention measures to minimise the insured risks, – features and benefits (such as compensation of full replacement costs, or depreciated, time value of assets), – exclusions or limitations, – details for notifying a claim, for instance, if both the loss and its notification must fall within the contract period, – who and to what extent bears the costs of investigating and establishing the loss, – contractual effects of a failure to provide relevant information by the insurer, – the remedies, costs and procedures of exercising the right of withdrawal, – contract renewals, – complaints handling?

3.4.        Insurance terms and conditions

Moral hazard corresponds to a behavioural
change of the individual who, once insured, has fewer incentives to prevent a
loss from occurring and, therefore, the negative impacts of the insured event
may be more likely to arise. This would be exacerbated if there were no
mechanism to reflect the losses in subsequent premiums.

To reduce the effects of moral hazard,
different kinds of insurance terms and exclusions – designed to instil
risk-mitigating behaviour – are employed as part of insurance contracts.

Deductibles or excesses oblige insured
parties to cover a portion of the loss themselves as a given amount is deducted
from the claim amount. The reasons for having them are to eliminate small
claims. Co-insurance is an arrangement where the loss is shared by the insured
and the insurer on a prescribed percentage basis. Contracts may also include
coverage limits (either an upper limit, or exclusion of certain vulnerable
items, e.g., weak constructions).

The above described contractual
arrangements may go beyond the ability, control or responsibility of the
insured party and may not be appropriate or effective to encourage
risk-reducing measures. Also, if increases in deductibles, excesses and
co-insurance are used to deal with additional disaster risks, low-income
insured persons claiming compensation for ‘insignificant’ damage may be
affected.

Questions (11) Do deductibles, excesses co-insurance and other exclusions effectively prevent moral hazard? What alternative terms and conditions could be appropriate for disaster insurance, given that the insured party may be unable to take effective risk reduction measures against a disaster?

3.5.        Data, research and
information

Before insurers offer coverage against an
uncertain event, its probability and consequences must be identified and
quantified. If it were certain or nearly certain that a particular loss in a
particular period and region would occur, the risk element would be absent and,
therefore, not insurable. Extremely low-frequency events may also be considered
hardly insurable or uninsurable in their totality since insurers may lack data
to correctly assess the risks.

The information asymmetry between the
insured and the insurer determines the underwriting process. Insurers need to
obtain adequate information to correctly define risk groups to avoid adverse
selection. If proper information about the risk is missing, risk-based premiums
are difficult to calculate. The general lack and ambiguity of data is a hurdle
to the further development of disaster insurance.

Better information would help to reduce
uncertainty. Public-sector agencies could provide stakeholders, including
insurers, with affordable access to reliable and precise data on past and
future natural hazards, e.g., as a public good from national meteorological
offices, flood management agencies or disaster observatories.

For researchers and public sector agencies,
such as flood management agencies, it is important to have improved access to
key technologies and networks, availability of skilled staff as well as access
to and comparability of data on insured (and non-insured) losses from past
disasters. This will help improve research on the impacts of past and future
natural hazards and can help improve disaster risk management strategies and
action developed and implemented by public-sector agencies. Comparable
aggregate loss data collected from the insurance industry (including
visualisation tools or risk information platforms) can also be shared with
public sector agencies as well as the private sector to improve risk
assessment.

Consumers also face barriers. One of these
is poor or no information - lack of awareness of the real risks could mean that
an individual’s perceived risk differs from their actual risk. Many individuals
perceive the probability of a disaster causing damage to their property as
being sufficiently low that they cannot justify investing in mitigation. In
making decisions that involve cost outlays, consumers need to take into account
the potential benefits of making the investment over a longer period of time.
Hazard and risk information in an easily readable format, such as mapped
hazards or risk information for a defined area, or as a risk matrix or risk
curve showing possible events and their likelihood, expected impacts, and
exposure level, can educate and raise awareness among consumers. Climate and
weather-related risk disclosure is, therefore, necessary as it allows investors
and consumers to incorporate additional information into their investment and
purchasing decisions. In addition to better information and greater access to
data, a higher level of standardisation of data (e.g., common definitions)
would increase the quality of the analyses.

The European Climate Adaptation Platform
(CLIMATE-ADAPT)[28]
could be used to collect and make available information on weather-related
insurance schemes or risk assessment approaches in Member States. Another
approach could be to provide this information as part of a comprehensive
package of information on disaster management.

Insurers could develop guidance for
decision makers and project developers and managers on how to use insurance to
support adaptation and disaster management. The guidance could include a
description of how to use insurance in the risk management strategy, i.e., how
to quantify and define which risks can be prevented and how and which ones
could be insured in a cost effective manner. This would improve the overall
economic efficiency of policy making, planning and project management.

Questions (12) How could data on the impacts of past disasters be improved (e.g., by using standard formats; improved access to and comparability of data from insurers and other organisations)? (13) How could the mapping of current and projected/future disaster risks be improved (e.g., through current EU approaches in flood risk mapping under the Floods Directive 2007/60/EC,[29] civil protection cooperation[30] and promotion of EU risk guidelines[31])? (14) How could better sharing of data, risk analysis and risk modelling methods be encouraged? Should the available data be made public? Should the EU take action in this area? How can further dialogue between insurance industry and policy-makers be encouraged in this area?

3.6.        Promoting risk financing
initiatives as part of EU development cooperation policy

Globally, insurance plays a key role in helping countries and
regions that are particularly vulnerable to disasters to create effective
financial contingency mechanisms to cope with the increasing economic costs of
disasters and global shocks.

Alternative, simplified risk transfer tools such as micro-insurance
products are being developed in developing countries. Parametric insurance
programmes, supported by the Commission, have also been implemented in third
countries which are particularly exposed to weather and catastrophic risks such
as droughts, earthquakes, and storms.

Particular attention should be given to strengthening cooperation
with key international partners (e.g., the World Bank, the International
Finance Corporation) and increasing the Union's external support for developing
countries to develop innovative risk financing solutions through insurance,
re-insurance or catastrophe bonds.

The Commission has recently proposed to develop an action plan on
steps to be taken to enhance resilience in developing countries, encompassing
also innovative approaches to risk management, and scale up existing good
practices in this area[32].

Questions (15) How can the Union most effectively help developing countries to create solutions for financial protection against disasters and shocks and what should be the priority actions? What types of partnerships with the private sector and the international institutions should be pursued for this purpose?

4.           Man-made disasters

Industrial hazards also evolve, not only
due to technological advances, but also due to evolving natural hazards.
Natural hazards and disasters can cause ‘natech’ accidents. Natural and
man-made disasters can be combined or can mutually aggravate each other.

4.1.        Environmental liability
and losses from industrial accidents

The Environmental Liability Directive
2004/35/EC[33]
encourages but does not oblige industrial operators to hold appropriate
financial security in order to remedy environmental damage as the result of
their activities. The Commission may re-examine the option of mandatory
financial security during the review of the Directive planned for 2014 in
conjunction with the Commission Report under Article 18(2) of the Environmental
Liability Directive 2004/35/EC[34].
However, the Directive does not cover environmental damage caused by "a
natural phenomenon of exceptional, inevitable and irresistible character."
Nor does the Directive cover damage to the environment caused by a prescribed
action with the aim of protecting against a natural disaster.

Insurance is one of the ways to obtain
financial security. However, the products often do not cover the full range of
liabilities under the Directive and in practice they do not provide for
unlimited coverage. It also remains difficult for insurers to develop specific
products as information on damage incidents and the resulting remediation costs
is not yet widely available[35].
Industrial operators could also be unaware of possible magnitude of damages.

Questions (16) What are the most important aspects to look at when designing financial security and insurance under the Environmental Liability Directive 2004/35/EC? (17) Are there sufficient data and tools available to perform an integrated analysis of relevant and emerging industrial risks? How can data availability, sharing and tool transparency be ensured? How can co-operation between insurers, business and competent authorities be strengthened to improve the knowledge base of liabilities and losses from industrial accidents?

4.2.        Third-party nuclear
liability insurance

Article 98 of the Euratom Treaty stipulates
that Member States are to ‘take all measures necessary to facilitate the
conclusion of insurance contracts covering nuclear risks’. Legal coherence
in the European Union is needed to reduce moral hazard, tackle victim
protection in different Member States and the impact on the functioning of the
internal market due to diverging financial liabilities of nuclear operators,
which may give rise to a distortion of competition.

There are currently many different rules on
nuclear third-party liability within the European Union. Most EU-15 Member
States base their provisions on the Paris Convention on Third Party Liability
in the Field of Nuclear Energy and the Brussels Supplementary Convention under
the auspices of the Organisation for Economic Cooperation and Development
(OECD). However, most EU-12 Member States are party to the Vienna Convention on
Civil Liability for Nuclear Damage under the auspices of the International
Atomic Energy Agency (IAEA). Some Member States are not party to any Convention
on nuclear liability. The Commission has, therefore, recently suggested taking a European approach on nuclear liability regimes[36].

Insurance against nuclear accidents is
currently organised in national insurance pools (or by a national operators’
pool). Insurers may find it difficult to insure nuclear operators beyond
certain limited amounts, for certain categories of damage (e.g., environmental
damage) or for long prescription periods (e.g., 30 years for damage to life and
health). National insurance or operators’ pools are also the first contact
point for victims of a nuclear accident.

The Commission is currently further
analysing this issue and will launch a public consultation shortly. Based on
the outcome of this analysis, the need for further steps, aiming at the
improvement of victim compensation in case of nuclear accidents and at reducing
differences in insurance amounts for nuclear power plants in different Member
States, will be determined.

4.3.        Offshore oil and gas
operators' liability insurance

The Hydrocarbons Licensing Directive
94/22/EC[37]
defines the conditions for granting and using authorisations for the
prospection, exploration and production of hydrocarbons. The Directive also
introduces objective and non-discriminatory financial capacity requirements for
the operating entities. These requirements set out the general principles to
ensure fair competition at the licensing stage, but without focus on risk
management, safety or environmental protection. The Commission has, therefore,
proposed further requirements concerning the risk management, environmental
liability and the financial capabilities of licensees and operators[38].

Offshore oil and gas industry has developed
different options for ensuring and demonstrating sufficient and adequate
financial capabilities. These mechanisms take various forms ranging from
private and self-insurances to safety mechanisms such as the Offshore Pollution
Liability Association (OPOL)[39]
scheme in the North East Atlantic area. Initial consultations with the offshore
oil and gas industry and insurers suggest that there is currently no option
that would be universally suitable for all oil and gas operators. It seems that
insurance products in the European Union[40]
cannot provide coverage for the major multi-billion euro accidents[41]. It also appears that larger
operators might favour and be able to afford self-insurance through a captive
entity whereas smaller operators might be financially restrained from
implementing this solution.

Hence there is no "one size fits
all" approach to risk financing in this sector. The current internal and
external solutions offered to cover these types and magnitudes of risk are
still nascent. However, some actors in the financial and insurance markets are swiftly
innovating. The questions remain as to the adequacy and appropriateness of
these mechanisms and how the offshore oil and gas sector would react and use potential
new insurance products (e.g., operation specific products). The financial
strength of the offshore oil and gas operator is a key driver to decide which
mechanisms would be most appropriate. Regardless of the approach chosen, the
solution should comprehensively take into account possible moral hazards and
guarantee the polluter pays principle.

Questions (18) Considering the specificities of the offshore oil and gas industry, what kind of innovative insurance mechanisms could be appropriate? Are there ways for the insurance industry to reduce the uncertainty regarding the assessment of risks and calculation of premiums? What type of information should be publicly available to promote the development of insurance market products to cover major accidents?

4.4.        Information rights of
victims of man-made disasters

Losses resulting from natural disasters are
covered by first-party insurance; while damages from man-made disasters covered
by third-party liability insurance. The first type is normally taken out by
individual property owners, the latter by individual industrial companies.

If the insured party becomes liable to a
third party, ordinarily the injured third party would be able to contact the
liable party, and, consequently, that liability would be covered by the
insurer. Claims handling could, however, be more pragmatic: the injured party could
make a direct claim against the insurer. To make that possible, the injured
party should have a disclosure right against the insured. Insured parties
could, therefore, be required, by law, to provide detailed information about
their insurance coverage.

Under the Environmental Liability
Directive, any natural or legal person can submit to the competent authority information
and observations about environmental damage resulting from a man-made disaster,
and request remediation action. Subsequently the competent authority shall
inform such persons of the actions taken, or may refuse to take action but
state the reasons why[42].
This information and observations may include data on the costs of the damage,
insurance available to fund the repair and so on. The recently adopted Seveso
III Directive 2012/18/EU[43]
obliges operators to include in their safety reports a description of any
technical and non-technical measures relevant for the reduction of the impact
of a major accident. Information on insurance could also be included. The
Directive, furthermore, provides that the safety report is to be made available
to the public upon request.

Questions (19) Should contractual conditions of third-party liability insurance policies be disclosed to third parties in case of man-made disasters? If so, how?

5.           Loss adjusting

The activities and profession of loss
adjusters are currently excluded from the scope of the Insurance Mediation
Directive 2002/92/EC[44].
The proposed revision of the Directive[45]
brings them under its scope and establishes a
simplified procedure of supervision.

Loss adjusting
in the wake of a disaster requires swift and coordinated action. The capacity to deal quickly with a substantial number of claims
and claimants, many of whom may have suffered personal physical injury, is
crucial. Loss adjusting related to cross-border
man-made disasters has an additional dimension since it is a matter for the liable person’s insurance company or its representatives, which
are, by definition, established in another Member State.

Questions (20) Are there specific aspects of loss adjusting which would benefit from more harmonisation? If so, which? Are there practical difficulties for loss adjusters to operate cross-border?

6.           General remarks

Question (21) This paper addresses specific aspects related to the prevention and insurance of natural and man-made disasters. Have any important issues been omitted or under-represented? If so, which?

7.           What are the next steps?

The Commission invites stakeholders to
comment on all the issues set out in this Green Paper and to respond to any or
all of the above questions.

On the basis of the outcome of this
consultation, the Commission will decide on the best course of action to take
on the issues outlined in this Green Paper, including legislative measures, as
appropriate.

The responses received will be available on
the Commission website, unless confidentiality is specifically requested, and
the Commission will publish a summary of the results of the consultation.

Stakeholders are invited to send their comments
before 30 June 2013 to the following email address: markt-consultation-disasterinsurance@ec.europa.eu.

[1]               Council Conclusions on Innovative Solutions for
Financing Disaster Prevention (3043rd Council meeting, Brussels, 8 and 9
November 2010).

[2]               http://ec.europa.eu/internal_market/insurance/consumer/natural-catastrophes/index_en.htm

[3]               Joint Research Centre, European Commission (2012), Natural
Catastrophes: Risk relevance and Insurance Coverage in the EU.

[4]               According to the Joint Research Centre, the main data
source for historical total losses is the Emergency Events Database (EMDAT). It
contains essential core data on the occurrence and effects of over 18 000 mass
natural and technological disasters in the world from 1900 to present. However,
information is not available for all recorded events: for example in the
extracted dataset, economic losses are available for 318 events (flood, storm,
earthquake and drought) out of 561 recorded events from 1990 to 2010.

[5]               Luterbacher, J., Dietrich, D., Xoplaki, E., Grosjean,
M., Wanner, H. (2004), European seasonal and annual temperature variability,
trends, and extremes since 1500, Science, 303, 1499–1503.

[6]               European Environment Agency, Climate change,
impacts and vulnerability in Europe 2012, An indicator-based report, EEA
Report No 12/2012.

[7]               Intergovernmental Panel on Climate Change (2012), Changes
in Climate Extremes and their Impacts on the Natural Physical Environment in
Managing the Risks of Extreme Events and Disasters to Advance Climate Change
Adaptation; European Environment Agency (2010), Mapping the impacts of
natural hazards and technological accidents in Europe, an overview of the last
decade.

[8]               Intergovernmental Panel on Climate (2012) Chapter 3: Changes in Climate Extremes and their Impacts
on the Natural Physical Environment in Managing the Risks of Extreme Events and
Disasters to Advance Climate Change Adaptation.

[9]               Joint Research Centre, European Commission (2010), Analysis
of Natech risk reduction in EU Member States using a questionnaire survey.

[10]             International Monetary Fund (2006), Insuring Public
Finances Against Natural Disasters—A Survey of Options and Recent Initiatives,
IMF Working Paper WP/06/199.

[11]             Bank for International Settlements (2012), Unmitigated
disasters? New evidence on the macroeconomic cost of natural catastrophes,
BIS Working Papers No 394.

[12]             Joint Research Centre (2012).

[13]             Annex A of the First Non-life Insurance Directive
73/239/EEC introduces the classification of risks into different classes of
insurance which determine, in particular, the scope of an insurer's licence and
product lines. Insurance class no. 8 "fire and natural forces" refers
to damage to or loss of property due to individual risks, namely fire,
explosion, storm, natural forces other than storm, nuclear energy and land
subsidence. Insurance class no. 9 "other damage to property" covers
all damage to or loss of property due to hail or frost.

[14]             Commission Regulation (EU) No 267/2010 of 24 March 2010
on the application of Article 101(3) of the Treaty on the Functioning of the
European Union to certain categories of agreements, decisions and concerted
practices in the insurance sector (OJ L 83, 30.3.2010, p. 1).

[15]             Such as the Caribbean Catastrophe Risk Insurance
Facility (CCRIF), the Pacific Catastrophe Risk Assessment and Financing
initiative (PCRAFI).

[16]             For instance the Global Index Insurance Facility as established
by the World Bank.

[17]             Regulation (EU) No 911/2010 of the European Parliament
and of the Council of 22 September 2010 on the European Earth monitoring
programme (GMES) and its initial operations (2011 to 2013) (OJ L 276, 20.10.2010, p. 1).

[18]             Communication from the Commission "A Community
approach on the prevention of natural and man-made disasters" (COM(2009)82
final); Council Conclusions on a Community framework on disaster prevention
within the EU (2979th Council meeting, Brussels, 30 November 2009) and
Communication from the Commission ''EU Strategy for supporting disaster risk
reduction in developing countries'' (COM(2009) 84 final).

[19]             G20/OECD methodological framework on disaster risk
assessment and risk financing.

[20]             Case C-59/01, Commission v Italy [2003] ECR I-1759. In Case
C-347/02, Commission v France [2004] ECR I-7557, the Court
clarifies that a system where insurers remain free to set the amount of the
basic premium is compatible with the principle to set insurance premiums. In
Case C-518/06, Commission v Italy [2009] ECR I-3491, the Court
further explains that, if national legislation outlines a technical framework
within which insurers must calculate their premiums, such a restriction on the
freedom to set rates is not prohibited by the Third Non-life Insurance
Directive 92/49/EEC.

[21]             According to the Joint Research Centre (2012),
risk-based premiums are not extensively adopted, as they are systematically
used in only six Member States for flood, in five Member States for storm and
in four Member States for earthquake insurance.

[22]             Joint Research Centre (2012).

[23]             Directive 2002/83/EC of the European Parliament and of
the Council of 5 November 2002 concerning life assurance (OJ L 345, 19.12.2002,
p. 1).

[24]             First Council Directive 73/239/EEC of 24 July 1973 on
the coordination of laws, regulations and administrative provisions relating to
the taking-up and pursuit of the business of direct insurance other than life
assurance (OJ L 228, 16.8.1973, p. 3).

[25]             Second Council
Directive 88/357/EEC of 22 June 1988 on the coordination of laws, regulations
and administrative provisions relating to direct insurance other than life
assurance and laying down provisions to facilitate the effective exercise of
freedom to provide services and amending Directive 73/239/EEC (OJ L 172,
4.7.1988, p. 1).

[26]             Council Directive
92/49/EEC of 18 June 1992 on the coordination of laws, regulations and
administrative provisions relating to direct insurance other than life
assurance and amending Directives 73/239/EEC and 88/357/EEC (third non-life
insurance Directive) (OJ L 228, 11.8.1992, p. 1).

[27]             Directive 2009/138/EC of the European Parliament and of
the Council of 25 November 2009 on the taking-up and pursuit of the business of
Insurance and Reinsurance (Solvency II) (OJ
L 335, 17.12.2009, p. 1).

[28]             http://climate-adapt.eea.europa.eu/

[29]             Directive 2007/60/EC of the European Parliament and of
the Council of 23 October 2007 on the assessment and management of floods risks
(OJ L288, 6.11.2007, p. 27).

[30]             Proposal for a Decision of the European Parliament and
the Council on a Union Civil Protection Mechanism COM(2011)934 final.

[31]             Commission Staff Working Paper "Risk Assessment
and Mapping Guidelines for Disaster Management" (SEC(2010) 1626 final).

[32]             For example the Caribbean Catastrophe Risk Insurance
Facility (€12.5 million), and the Global Index Insurance Facility (€24.5
million).

[33]             Directive 2004/35/EC of the European Parliament and of
the Council of 21 April 2004 on environmental liability with regard to the
prevention and remedying of environmental damage (OJ L 143, 30.4.2004, p. 56).

[34]             Report from the Commission under Article 14(2) of
Directive 2004/35/CE on the environmental liability with regard to the prevention
and remedying of environmental damage (COM(2010) 0581 final).

[35]             COM(2010) 0581 final and http://ec.europa.eu/environment/legal/liability/index.htm.

[36]             Communication from the Commission "Energy 2020 A
strategy for competitive, sustainable and secure energy" (COM(2010) 0639
final); Communication from the Commission on the interim report on the
comprehensive risk and safety assessments ("stress tests") of nuclear
power plants in the European Union (COM(2011) 0784 final), Communication
from the Commission on the comprehensive risk and safety assessments
("stress tests") of nuclear power plants in the European Union and
related activities (COM(2012) 571 final).

[37]             Directive 94/22/EC of the European Parliament and of
the Council of 30 May 1994 on the conditions for granting and using
authorizations for the prospection, exploration and production of hydrocarbons
(OJ L 164 , 30.06.1994, p. 3); see also http://ec.europa.eu/energy/oil/licensing_en.htm.

[38]             Proposal for a Regulation of the European Parliament
and of the Council on safety of offshore oil and gas prospection, exploration
and production activities (COM(2011) 0688 final).

[39]             http://www.opol.org.uk/

[40]             In the Gulf of Mexico insurance coverage up to 10 B$
for sudden oil spills is now available. In other parts of the world traditional
offshore insurances provide coverage up to 1-2 B $.

[41]             The Commission is conducting a study exploring the
feasibility of creating a fund to cover environmental liability and losses
occurring from industrial accidents.

[42]             See Article 12 of Directive 2004/35/EC.

[43]             Directive 2012/18/EU of the European Parliament and of
the Council of 4 July 2012 on the control of major-accident hazards involving
dangerous substances, amending and subsequently repealing Council Directive
96/82/EC (OJ L 197, 24.7.2012, p. 1).

[44]             Directive 2002/92/EC of the European Parliament and of the
Council of 9 December 2002 on insurance mediation (OJ L 9, 15.1.2003, p. 3).

[45]             Proposal for a Directive of the European Parliament and
of the Council on insurance mediation (recast) (COM(2012) 360 final).