Economics of Insurance Against Natural Disaster Risks

Abstract

Increasing natural disaster losses in the past decades and expectations that this trend will accelerate under climate change motivated the development of a branch of literature on the economics of natural disaster insurance. A starting point for assessing the implications of climate change for insurance and developing risk management strategies is understanding the factors underlying historical loss trends and the way that future risks will develop. Most studies have pointed toward socioeconomic developments as the main cause of historical trends in natural disaster risks. Moreover, evidence reveals that climate change has been a contributing factor, which is expected to grow in importance in the future. Several supply and demand side obstacles may prevent natural disaster insurance from optimally fulfilling its desirable function of offering financial protection at affordable premiums. Climate change is expected to further hamper the insurability of natural disaster risks, unless insurers and governments proactively respond to climate change, for example by linking insurance coverage with risk reduction activities. A branch of literature has developed about how the functioning of insurance should be improved to cope with climate change. This includes industry-level responses, reforms of insurance market structures, such as public–private natural disaster insurance provision, and recommendations for addressing behavioral biases in insurance demand and for stimulating risk reduction. In view of the rising economic losses of natural disasters, this field of study is likely to remain an active one.