Novel and improved insurance instruments for risk reduction

Executive summary

Managing risk and adapting to climate change is essential to minimise the losses and damages during and after disasters and extreme weather events. Several risk management approaches exist, one of which is the use of economic instruments (EI). Examples of EIs include taxes, subsidies and insurance to deliver financial protection in the event of a disaster, yet their design and the way in which they operate is essential to their success in mitigating and minimising hazard loss. Insurance is one example of an EI and functions as a tool to share and transfer risks and losses and is useful in aiding adaptation to climate change. Within this context insurance may be delivered using a range of approaches, which together contribute to its feasibility for delivery and operation as well as the potential for incentivising behavioural change. Yet undesirable aspects also exist and can include a lack of comprehensive information and cognitive biases, as well as financial constraints and moral hazard.

This paper considers two key questions in the context of natural disaster insurance and risk reduction:

How to assess existing insurance offerings and how to design new schemes? It brings together theoretical work, qualitative and quantitative approaches, and case-study evidence from across Europe under the ENHANCE project.

We introduce six different methodologies for assessing the linkages between insurance and risk reduction: Stress testing; investigation of flood insurance and moral hazard; estimation of effectiveness of household-level flood risk mitigation measures; assessment of risk based insurance pricing incentives for flood risk mitigation; analysis through a Risk Reduction Framework; and investigation of the design principles of insurance.

We then explore the applicability of those six methods for five different cases studies, in which insurance is either non-existing, proposed, or being reformed or revised: Multi-hazard risk assessment in Po River basin basins (Italy); Flood insurance in England (United Kingdom); Insurance and forest fire resilience in Chamusca (Portugal); Flood risk management for Critical infrastructure: Port of Rotterdam (The Netherlands); Disaster insurance in Romania and the EU Solidarity Fund.

Our analysis concludes with a discussion of how the six methods could assist the development of innovative responses to natural hazard risk management, particularly in a multi-sectoral partnership context.