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Environmental information systems
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Description
Disaster risks and losses are of great concern for society, since they have increased over the last years. These events are expected to further intensify due to factors such as demographic development, land use changes, expansion of residential and economic activities in disaster-prone areas and projected climate change. Evidence shows that climate change has already increased the frequency and severity of certain extreme weather- and climate-related events, such as droughts, heat waves and heavy precipitation, in several European regions. These trends are expected to continue unless effective climate change mitigation and adaptation measures are implemented (EEA Report 15/2017). Moreover, risks induced by climate will also impact and transform the insurance industry. (EIOPA, 2022). Therefore, the implementation of compressive risk management mechanism (such as insurances), gains more and more importance.
Insurance transfers risk from an insured person, object or organisation to an insurer. Compensation depends on the assessment of losses caused by the specified hazard events, e.g. crop loss in agriculture, losses in houses from flooding, forest losses due to storm or forest fires. For extreme weather, insurance is a valuable tool because it helps prevent that the financial losses do not turn into long term economic damages. If a house or a business is damaged, insurance can cover the costs of rebuilding or compensation, allowing the affected individuals to recover quickly. Before insurance can be provided for extreme weather events, the insurer needs to identify the risk, quantify how much damage it could cause, and be able to bear the costs if the extreme event occurs. Finally, in order to have insurance for extreme weather, it must be unpredictable. The exact time and location of the event cannot be known in advance.
The European Commission’s 2013 Green Paper on insurance for natural and man-made disasters is part of the Adaptation Strategy package. It aims improve how insurers manage climate change risks, expand access to disaster insurance, and unlock the full potential of insurance pricing and other financial products.
A European Commission report on insurance of weather and climate-related disaster risk analyses different insurance schemes established in several Member States. Based on their assessment the insurance markets (across countries and sectors) can be divided into three broad groups:
- Voluntary insurance market: In this market, policyholders decide whether to buy insurance coverage and the insurers decide if they will provide the coverage.
- Semi-voluntary insurance market: It is similar to the voluntary market, where both the insurer and the policyholder can choose to participate. However, there may be indirect pressure, like requirements from mortgage lenders or informal agreements, which encourage individuals to take part in the insurance market.
- Mandatory markets: In this market, either the insurer or the policyholder is legally required to participate. For example, insurers might be legally obligated to offer coverage for extreme weather, and policyholders may be required by law to buy fire insurance that includes coverage for extreme weather events.
Some countries (e.g. France, Switzerland) have state or quasi-state monopoly insurance while other countries (e.g. Germany, Italy, United Kingdom) have commercially structured “free market solutions”, which are systematically coupled with state-funded ad-hoc relief. Other countries (e.g. Austria, Denmark) have public disaster funds financed by tax-payers' money and still others have various mixed solutions of private insurance providers supplemented by public disaster funds (e.g. Belgium, the Netherlands, Norway) (Schwarze et al., 2009). Spain has a public-private partnership scheme where the public entity (Consorcio de Compensación de Seguros - CSS) covers extraordinary climate risks (and others) and collects its premiums through a proportional surcharge included in the invoices of the private companies (EEA, 2017).
Insuring against climate-induced risks is rapidly becoming a priority for individuals and firms. Business management practice naturally involve risk diversification strategies. In view of the increasing relevance of climate-related risks, in terms of damages to physical assets and disruption of business activities, it is advisable that firms consider subscribing insurance policies against natural disasters, or other climate impacts likely to impact their operations.
Additional Details
Adaptation Details
IPCC categories
Institutional: Economic options, Institutional: Law and regulationsStakeholder participation
Stakeholders, such as public asset owners, farmers, private property owners, and business operators, can influence risk management in the insurance sector. They create incentives or requirements that help reduce the impact of extreme weather events. One example is price signaling: if homeowners strengthen their roofs against hailstorms, they might pay a lower insurance premium or have a smaller deductible. Another example is including resilience requirements in insurance policies; if a policyholder does not take steps to reduce risks, their payout could be lower.
In various countries a “state guarantee” system is in place, where a “disaster fund”, helps cover damage above a certain threshold. This ensures that private insurers stay financially stable and can offer affordable premiums. However, this can reduce the incentive to undertake an insurance, especially outside highest risk areas. In these cases, the may not work properly, and premiums can become too expensive for most people.
Success and limiting factors
An insurance scheme's performance is mainly determined by the long-term costs and benefits of insurance, which remain the key indicator. For climate change, these costs and benefits should be seen together with a broad range of risk management tools (prevention, protection, early warning). The risk management objectives depend on the expectations that governments, insured parties or insurers may have. An insurance scheme based on solidarity (with public support and individual contributes based on income) will achieve maximum coverage in order to evenly distribute risk. Climate risk management insurance will increase risk awareness and provide incentives to increase resilience through adaptation measures.
However there are also voices that state that insurance is maladaptive, as insurance regimes reinforce exposure and vulnerability as they might favour actions which preserve the ‘status-quo’ rather than enabling adaptive behaviour such as transformative adaptation (e.g. O’Hare et al., 2015). In this perspective, insurance shall be seen as part of a broader approach to risk management and adaptation.
Costs and benefits
Insurance companies spread financial risk across all policyholders, and by charging higher premiums for higher risks, they encourage individuals to take steps to reduce their own risks. This helps lower the cost of damage if an event happens. However, insurance becomes less attractive for high-risk households or farmers when premiums reflect the underlying risk. At the same time, although lower risk policyholders have a weaker incentive to reduce risk, they are more likely to buy insurance since premiums are more affordable.
This trade-off between premium affordability and risk-reduction incentives is important but difficult to balance and is often influenced by the differing risk management objectives of individual countries and/or stakeholder groups.
Legal aspects
The EU Solvency II Directive (2009/138/EC) codifies and harmonises the EU insurance regulation. Primarily this concerns the amount of capital that EU insurance companies must hold to reduce the risk of insolvency. 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 grants an exemption to the application of competition rules to certain types of agreements in the insurance sector (for more detailed information see here).
Implementation time
Lifetime
Insurance schemes last normally as long as a contract is agreed between the insurer and the insured item. Most contracts have an annual duration and are yearly renewed, including the revision of contract, such as the insurance premium.
Reference information
Websites:
References:
EU, (2018). Using insurance in adaptation to climate change. Publications Office of the European Union,
Ramboll Environment and IVM, (2017). Insurance of weather and climate‑related disaster risk: An inventory and analysis of mechanisms to support damage prevent in the EU. Final report. European Commission.
Published in Climate-ADAPT: Mar 25, 2020
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This translation is generated by eTranslation, a machine translation tool provided by the European Commission.