Insurance can play a vital role in stimulating flood risk reduction and decreasing losses. We learned this the hard way… However, there remains a gap between the theoretical potential described by academics and the actual engagement of insurers in practice. This article will examine how insurers in developed countries are currently involved in various flood risk reduction measures, and the different incentives they use to promote risk mitigation by policyholders and government actors.
Flood risk is determined by the hazard itself, the exposed population and assets, and the vulnerability of the affected community. Flood risk management relies on a mix of structural and non-structural measures to address these different risk components. While emergency response and adaptation focus on reducing losses from high-frequency flood events, successful land use planning and building codes have the potential to avoid losses from both minor and extreme floods.
Insurance has a special role in this context, as it is not primarily aimed at reducing the initial flood hazard, but rather at compensating for losses after severe, low-probability events and facilitating recovery. Nonetheless, there is growing recognition that insurance can provide valuable incentives for other flood risk reduction activities.
Flood insurance schemes in developed countries vary considerably in terms of the degree of government involvement, legal requirements, availability and demand, whether insurance is compulsory, and market penetration. These framing conditions influence the extent to which insurers engage in flood risk reduction and the types of incentives they use.
Insurer Engagement in Flood Risk Reduction Measures
Risk Knowledge and Communication
One of the most common flood risk reduction activities undertaken by insurers is raising public awareness through communication and education campaigns. These aim to inform citizens about their personal flood risk and the benefits of insurance and risk reduction measures. Successful examples include information campaigns in Germany, France, and the USA, which have helped to increase insurance penetration rates.
Insurers also often cooperate with government agencies to improve the quality of flood hazard maps and risk data. For instance, in Germany, insurers integrated official flood hazard zones into their own risk classification system, leading to more properties being considered insurable. Similarly, in the UK and Austria, insurers worked with public authorities to enhance flood mapping. The exchange of data between insurers and municipalities can be mutually beneficial, as it allows both parties to enhance their knowledge of local flood risks.
Land Use Planning and Building Codes
Insurers’ involvement in land use planning and building codes is more limited, as these are primarily governmental responsibilities. However, in countries with public insurance schemes, such as the USA and Switzerland, insurers can exert significant influence.
In the USA, the National Flood Insurance Program (NFIP) sets minimum requirements for participating municipalities regarding flood zoning and building codes. For example, it requires new buildings or heavily damaged properties to be elevated above the 100-year flood level. Some communities have even adopted stricter standards voluntarily.
In Switzerland, insurers can check building plans and enforce hazard-adapted construction requirements in high-risk areas. They can also influence land use planning by denying coverage in certain locations, effectively discouraging development in flood-prone areas.
Property-Level Adaptation Measures
Insurers have various options to incentivize policyholders to implement property-level adaptation measures, such as elevation, flood-proofing, or the relocation of valuable items. This includes requiring such measures as a condition of coverage, allowing for flood-adapted reconstruction after damage, or providing premium discounts for risk-reducing actions.
In countries with private insurance systems, such as Germany and Denmark, insurers are increasingly making the implementation of property-level protection a prerequisite for coverage. In the USA, the NFIP offers grants to policyholders to implement adaptation measures, although the eligible measures are currently limited.
Large-Scale Structural Measures
Direct insurer investment in large-scale structural flood protection measures, such as dams, dykes, or retention basins, is rare. This is likely because insurers do not perceive it as their primary role, and the long payback periods make it less profitable.
However, in public insurance schemes or where insurance is compulsory, such as in Switzerland, France, and Spain, insurers are more involved. In Switzerland, for example, public monopoly insurers invest around 15% of their premium income in prevention, including co-funding large-scale measures.
In the UK, private insurers and the government have an agreement that insurers will provide coverage if the government invests in large-scale infrastructure to achieve a minimum flood protection standard. But this arrangement has been criticized, as insurers did not pass on the benefits of improved protection to policyholders through lower premiums.
Incentives for Flood Risk Reduction
Risk-Based Pricing
Theoretically, risk-based premiums and deductibles could provide a strong financial incentive for policyholders to implement risk reduction measures. However, this approach is more the exception than the rule in practice.
Barriers include a lack of detailed risk data, the need to disentangle flood risk from other bundled perils, and requirements to maintain affordability. Additionally, cross-subsidies between low and high-risk areas often distort the price signal.
Some insurers are experimenting with alternative approaches, such as offering premium discounts or lower deductibles as a reward for risk-reducing actions, rather than fully risk-based pricing. The NFIP in the USA also links its community rating system to premium reductions for municipalities that implement certain flood mitigation measures.
Contractual Requirements
Insurers can also use the insurance contract itself to incentivize risk reduction, for example, by requiring policyholders to implement specific adaptation measures as a condition of coverage. This approach is more common in public insurance schemes, where competition is less of a concern.
In Denmark and Iceland, insurers can refuse coverage or restrict it if policyholders do not undertake required risk reduction measures. In Germany’s private market, some insurers are now making property-level protection a prerequisite, especially in high-risk areas.
Financial Assistance
Both public and private insurers sometimes provide financial assistance, such as grants or subsidized loans, to support the implementation of property-level or large-scale structural protection measures. The NFIP in the USA offers grants to policyholders, and the Barnier Fund in France subsidizes municipal risk prevention plans and household adaptation investments.
However, the actual uptake and effectiveness of these financial assistance programs are often not well evaluated. Ensuring the affordability of insurance and risk reduction measures for low-income households remains a challenge.
Public-Private Partnerships in Flood Risk Management
Flood risk management increasingly involves cooperation between the public and private sectors. Public-private partnerships (PPPs) can take various forms, from defining the overall insurance scheme to more limited collaborations, such as data sharing or joint financing of risk reduction measures.
In countries with public insurance schemes, such as the USA and Spain, the government often relies on private insurers to maintain the customer relationship and distribute policies. Conversely, in private markets, insurers may cooperate with authorities on issues like land use planning or large-scale infrastructure.
The degree of insurer engagement in risk reduction seems to depend on the framing conditions of the national insurance scheme. Insurers in public or compulsory systems appear more proactive, as they face less market competition and are not driven by profit maximization.
Moving forward, new types of PPPs may emerge, involving collaborations between insurers, banks, and governments to develop innovative financing solutions that promote both insurance coverage and risk reduction.
Conclusion
While the theoretical potential of insurance to incentivize flood risk reduction is well-documented, the actual engagement of insurers remains limited in many countries. Nonetheless, this analysis has identified several ways in which insurers are currently involved, from communication and data exchange to more direct interventions in land use planning, property-level adaptation, and large-scale protection measures.
The effectiveness of these insurer activities depends heavily on the framing conditions of the national insurance system. Public or compulsory schemes seem to provide a more conducive environment for proactive insurer engagement in risk reduction. In private markets, insurers face greater barriers, such as market competition and the need to maintain affordability.
To unlock the full potential of insurance in stimulating flood resilience, a combination of approaches is likely needed, including risk-based pricing, contractual requirements, financial assistance, and innovative public-private collaborations. Rigorous evaluation of these different mechanisms will be crucial to identify best practices and guide the evolution of flood insurance programs in the years to come.
Tip: Regularly inspect and maintain flood barriers and drainage systems
