The social security for climate change risks
Authors:   , Tesselaar Max 
Published: February 2024

Increasing trends in climatic disaster damage call for societies to adapt, so that damage caused by such events is limited and restored quickly. The insurance industry is an important economic sector to facilitate climate change adaptation. Adequate compensation for destroyed property is essential to enable those unfortunate individuals to recover economically. Moreover, insurance is a potentially useful instrument to stimulate risk-reduction effort by policyholders and, thereby, contribute to shaping a society that is more resilient to natural hazards.

The ability of insurance to perform these functions---that is, to financially cover society against disasters, and to stimulate adaptation to risk---is under pressure. Throughout Europe, the insurance protection gap regarding natural hazards---that is, the amount of natural hazard risk that is not insured---is increasing, as a result of rising risks and stagnant or declining insurance uptake. Climate change, therefore, calls for a revision of natural hazard insurance systems.

Fundamentally, the design of natural hazard insurance is a political choice between solidarity and efficiency principles. On the one hand, insurance should be affordable and cover all citizens at risk of natural hazards, while on the other hand insurance should contribute to the development of a resilient society by stimulating risk-reduction by policyholders. The research presented in this dissertation aims to assess different aspects of these consequences, including unaffordability of premiums, societal coverage of insurance, and incentives for risk-reduction by policyholders. The objective of the assessments is to inform the design of robust insurance markets, which are able to financially protect citizens against natural disasters while also promoting risk conscious behavior.

Chapters 2 and 3 in this dissertation show that risk-sensitive flood insurance premiums are likely to rise in floodplains as a result of climate- and socio-economic change. Rising premiums cause increasing pressure on households' spendable income, causing flood insurance uptake to decline. Chapter 4 shows that besides rising costs of insurance, the anticipation of government compensation for uninsured flood damages also partly contribute to the decline in insurance uptake and, therefore, the rising insurance protection gap. Diminishing demand for insurance coverage causes higher pressure on public budgets when these are called upon to cover uninsured flood damages. Chapter 6 finds that such implicit public liabilities have negative indirect macroeconomic impacts on tax income, GDP, and welfare. Research presented in these chapters call for flood insurance uptake requirements in order to reduce the flood insurance protection gap. Affordability of flood insurance may be preserved by introducing a public reinsurer and by limiting the degree to which premiums reflect the risk of individual policyholders.

Contrary to the appeal for more risk-sharing is the need to integrate insurance in a larger flood risk management framework, where insurance should contribute to stimulating climate change adaptation. By accurately pricing insurance based on risk of individual policyholders, these individuals are encouraged to reduce risk. Chapter 5 of this dissertation shows that risk-based premiums discourage households from settling in flood-prone areas. Considering this, risk-based premiums may contribute considerably towards shaping a flood-resilient society, and increasing the degree of risk-sharing amongst policyholders with different levels of risk obstructs the incentive given by insurance to adapt to risk.

The contradicting demands of insurance policy design, with on the one hand the need to maximize coverage and preserve affordability, while on the other hand the need to stimulate risk-adaptation, means a solution could exist in combining these approaches. In various studies presented in this dissertation, the combination of mandatory insurance, public reinsurance, and capped risk-based premiums is identified as an optimal solution for the flood insurance industry to cope with the challenges posed by climate change.