Flood Insurance and Flood Risk Reduction
Summary and Keywords
The rapid increase in losses from flooding underlines the importance of risk reduction efforts to prevent or at least mitigate the damaging impacts that floods can bring to communities, businesses, and countries. This article provides an overview of how the science of disaster risk management has improved understanding of pre-event risk reduction [or disaster risk reduction (DRR)]. Implementation, however, is still lagging, particularly when compared to expenditure for recovery and repair after a flood event. In response, flood insurance is increasingly being suggested as a potential lever for risk reduction, despite concerns about moral hazard. The article considers the literature that has emerged on this topic and discusses if the conceptual efforts of linking flood insurance and risk reduction have led to practical action. Overall, there is limited evidence of flood insurance effectively promoting risk reduction. To the extent there is, it suggests that more complex behavioral aspects are also at play. Further evidence is required to support this potential role, particularly around data and risk assessment, and the viability of different risk reduction measures.
The devastating impacts of floods are on regular display across the world, causing significant loss of lives, destruction of homes and businesses, and disruption to communities and commercial processes. . In 2016, flooding was the costliest kind of natural disaster, with total global economic losses estimated at USD$62 billion, with USD$28 billion of this related to summer flooding along the Yangtze River in China (AON Benfield, 2016). Flooding events can also be deadly, with 484 people killed by flooding in India alone (AON Benfield, 2016). In many parts of the world flood losses are expected to rise, due to climate change and socioeconomic trends, with more people and more assets located in harm’s way (Intergovernmental Panel on Climate Change, 2012). This is already putting more stress on existing flood risk management measures (Jongman et al., 2014). In particular, the United Nations Office for Disaster Risk Reduction (UNISDR) and the Centre for Research on the Epidemiology of Disasters (CRED) note that the number of people affected by flooding per year is rising globally; for example, South America has experienced a fourfold increase in the annual number of people affected in little over a decade (UNISDR & CRED, 2015). By 2060, more than one billion people may live in cities at risk (BBC News, 2016).
For some parts of the world, flood risk has become an existential problem—for example, in low-lying island states threatened by sea-level rise. A reminder of this risk occurred in 2016 with the inundation of five of the Solomon Islands (Albert, Grinham, Gibbes, Leon, & Church, 2016). Elsewhere, the main concern with flooding tends to be the economic costs and detrimental impacts on livelihoods, with floods wiping out development gains and locking those affected in poverty traps (UNISDR, 2015; Intergovernmental Panel on Climate Change, 2014; Ludwig et al., 2007). As seen with the example of the Thailand floods in 2011, which killed 815 and affected the operations of a number of major international businesses (Setboonsarng, 2011), these impacts can be felt locally and globally through supply chains and international business processes.
In response, measures to reduce existing risks, avoid new risks, and manage residual risks are needed (UNISDR, 2015). Achieving this requires a forward-thinking approach that considers both current and future risks (e.g., Merz et al., 2014) and brings together a broad suite of stakeholders who are capable of promoting and implementing measures that address the risk drivers beforehand as well as the impacts of floods once they occur. Measures should not begin with an event, but should start with systematically identifying risk, assessing and prioritizing those risks, and making decisions on prevention measures; monitoring and regularly updating is also crucial (Thieken, Mariani, Longfield, & Vanneuville, 2014; Thieken et al., 2016).
The need for this kind of anticipatory approach has been acknowledged and promoted through international frameworks, including the Sendai Framework for Disaster Risk Reduction (2015–2030) (SFDRR) and the European Directive (2007/60/EC) on the assessment and management of flood risks (Floods Directive). Science plays a key role in supporting a move toward more anticipatory flood risk management. A better understanding of risks, risk trends, and the possible response mechanisms is important, as acknowledged in the growing number of fora that promote science–policy interaction on flood risk (see Poljansek, Ferrer, De Groeve, & Clark, 2017).
This approach is yet to receive significant traction, however, with only 12% of funds being dedicated to risk reduction and 88% going to postevent response, repair, or reconstruction (Tanner et al., 2015a). Similarly, annual funding from congressional appropriations on predisaster mitigation grants in the United States has paled in comparison to the amount spent on recovery assistance (National Institute of Building Sciences, 2016).
Discussions about ways to address this imbalance and promote risk reduction in the face of rising risks have placed increasing focus on flood insurance. While foremost designed as a financial compensation measure that distributes the costs of floods across the group of those insured, flood insurance can also influence risk behavior and promote a culture of risk management. Rising risks, however, are also becoming a threat to insurability: The costs of providing insurance solutions will rise unless more preventative measures such as flood defense investment and stricter building codes are applied. In a number of countries, this trend is already resulting in flood insurance becoming increasingly unaffordable for those living in high-risk areas. Therefore, effective risk reduction is expected to play a significant role in the affordability and availability of insurance, but it is far from clear how these two approaches interact and how insurance itself can promote more risk reduction.
This article provides an overview of how science has improved our understanding of flood risk reduction and the role of flood insurance. Generally speaking, much of the literature around flood risk reduction and insurance is limited by a lack of empirical studies (e.g., on the effectiveness of different resilience measures), but the use of surveys and new methodologies such as agent-based modeling (ABM) are offering new insights. The concluding discussion considers if the conceptual efforts of linking flood insurance and risk reduction have led to practical action and identifies areas that require further research.
The Underlying Concepts and Principles of Disaster Risk Reduction
The United Nations Office for Disaster Risk Reduction (UNISDR), whose purpose is the promotion of disaster risk reduction (DRR) across the international community, defines DRR as “the concept and practice of reducing disaster risks through systematic efforts to analyze and manage the causal factors of disasters, including through reduced exposure to hazards, lessened vulnerability of people and property, wise management of land and the environment, and improved preparedness for adverse events” (UNISDR, 2009).
DRR has received growing recognition from scientists and practitioners (Poljansek et al., 2017), spurred by the need to move beyond responsiveness and relief to addressing underlying vulnerability through ex-ante disaster mitigation and preparedness (Shaw, Mallick, & Islam, 2013). Indeed, “… abatement of vulnerability is the primary need in disaster risk reduction” (Poljansek et al., 2017; UNISDR, 2015).
Early scientific efforts acknowledging the need for a greater focus on societal vulnerability developed in the 1970s when it became apparent that resources could be utilized more efficiently if greater focus was placed on predisaster planning and not just responsiveness (Lewis, O’Keefe, & Westgate, 1976). The lynchpin of these early efforts was the disaster risk management cycle (see Figure 1), which typically recognizes the need for prevention, preparedness, response, and recovery.
Efforts to achieve risk reduction tend to be considered as part of the “prevention” and “preparedness” elements of the disaster risk management cycle. Activities undertaken as part of the “response” to disasters and, in particular, the “recovery” from disasters, however, can also have a significant impact on risk levels, for example with regard to building back after a disaster: rebuilding a community or a home in a resilient way will decrease future risks. Therefore, a more holistic view of risk reduction being an integral component of all disaster risk management phases seems more appropriate. This has been acknowledged by the Sendai Framework for Disaster Risk Reduction (SFDRR), which considers the need to “reduce existing risk,” “avoid new risks,” and “manage residual risks,” not just prior to an event but also in relation to activities during and after (UNISDR, 2015).
Ultimately, such activities should promote resilience, defined by UNISDR as “[t]he ability of a system, community or society exposed to hazards to resist, absorb, accommodate to and recover from the effects of a hazard in a timely and efficient manner, including through the preservation and restoration of its essential basic structures and functions” (UNISDR, 2009). From this premise, a number of key points have developed over time:
• Local management of natural hazards is typically more effective than regional or national management, reflected in recent studies that highlight the need for greater engagement with local stakeholders [e.g., see Jenkins, Surminski, Hall, & Crick, 2017].
• Multihazard approaches tend to be more effective than single hazard approaches [for an overview, see Zschau, 2017].
In order to encourage key stakeholders to engage in risk reduction, they generally need to perceive a benefit for themselves (Aerts & Mysiak, 2016). Consistent with the last point, approaches to risk reduction measures have been largely economic, with a particular focus on comparing the costs and benefits of a measure in order to determine its viability. This cost–benefit analysis (CBA) approach has been recognized as established and proven (Chadburn, Ocharan, Kenst, & Venton, 2010) and is enshrined in international instruments that impact the analysis of flood risk reduction measures. For example, the Floods Directive provides that flood risk management plans need to take into account all the costs and benefits of those plans. Similarly, the SFDRR makes a number of references to the cost-effectiveness of DRR. In some areas, CBA has even become a statutory requirement; for example, in Germany (Brockmann et al., 2015).
A number of studies highlight the significant cost-effectiveness of different flood risk reduction measures. For example, figures in the U.K. suggest property level measures have a cost–benefit ratio in excess of £5 for every £1 invested [Department for Environment, Food & Rural Affairs (DEFRA), 2016]. Similarly, a recent study by Hugenbusch and Neumann (2016) into examples of predominantly structural measures to address riverine and coastal flooding shows that the majority of them have had positive cost–benefit ratios. Other studies explore the cost-effectiveness of different risk reduction measures, such as that of Wilby and Keenan (2012), who find that the placement of temporary flood barriers may be more cost-effective than some of these permanent measures (depending on the frequency of flooding). Other examples are empirical assessments of the effectiveness of household risk reduction, such as that of Kreibich, Thieken, Petrow, Müller, and Merz (2005) for the Elbe river in Germany, who show that flood-adapted buildings face 46% less damage to structures and 48% less damage to contents, while flood-adapted interior fittings reduced damage to buildings and contents by 53%. Kousky and Michel-Kerjan (2015) identify the benefits of elevated homes in the United States, while Pasterick (1998) finds that buildings constructed to meet stricter construction requirements, as outlined in the National Flood Insurance Program after 1975, have faced significantly less damage than those built pre-1975.
Despite these findings, investment in and uptake of risk reduction measures still tend to be limited due to a lack of risk awareness, limited incentives, or a combination of psychological and political factors (Bubeck, Botzen, Kreibich, & Aerts, 2012; Tanner et al., 2015a). The underestimation of the risk in the absence of experience with the hazard and the use of short-term planning horizons are also limiting factors (Kunreuther, 1996; Botzen, Aerts, & van den Bergh, 2009; Kellens, Terpstra, & De Maeyer, 2013). Collaboration across disciplines can offer new insights into those challenges and propose innovative approaches toward overcoming them. An example is the Triple Resilience Dividend concept (Tanner et al., 2015b), which attempts to develop a more positive narrative around risk reduction by highlighting cobenefits and wider development gains that can be achieved through risk reduction investments, even in the absence of disasters. The challenges in moving toward greater risk reduction have also led to a growing recognition of the need to engage a broad range of measures, instruments, and stakeholders across a range of industries, including insurance.
Flood Insurance as a DRR Measure
For centuries, insurance has been used as a tool for spreading risk, including those caused by natural disasters such as flooding. Over time, a range of different approaches to flood insurance have evolved, resulting in a patchwork of flood insurance schemes (Aakre et al., 2010; Bruggeman, Faure, & Fiore, 2010; Paudel, 2012; Schwarze et al., 2011; Surminski, 2015). The penetration rates, product type, and operational mechanics of flood insurance schemes vary significantly from country to country (particularly between developed and developing markets, where insurance in general is still nascent) and, occasionally, between different regions in the same country. Some of the major distinctions between these mechanisms include:
• Whether flood insurance is provided by the private insurance market (e.g., flood insurance in Ireland), with state intervention (e.g., the National Flood Insurance Program in the United States), or a combination of both (e.g., Flood Re in the United Kingdom). Public–private arrangements are common (Paudel, 2012).
• Whether flood insurance is indemnity-based or index-linked. Indemnity-based schemes (i.e., those that indemnify for the quantity of loss) tend to be adopted in developed countries that charge risk-based pricing (e.g., the insurance systems in Ireland and Australia) or provide some degree of subsidy (e.g., reinsurance under Flood Re, the UK’s new reinsurance pool), while parametric index-based schemes (i.e., those that pay out regardless of the quantity of loss by reference to an index) tend to be adopted in developing countries and are designed to promote availability (Surminski, 2015).1
• Whether flood insurance is mandatory or voluntary. In most countries, it remains voluntary, but there are examples such as Spain and France where there is a mandatory component (Botzen & van den Bergh, 2009; Paudel, 2012).
The kind of flood insurance scheme an individual country adopts is influenced by a broad range of factors that affect supply and demand. For example, flood insurance is significantly underdeveloped in developing countries (Warner & Spiegel, 2009) due to factors such as poor distribution channels, a lack of available data for determining risk, and a lack of financial literacy and access in rural areas for potential policyholders (Surminski & Oramas-Dorta, 2014; Dougherty-Choux, Terpstra, Kurukulasuriya, & Kammila, 2015). Government intervention has also increased in markets where flood insurance is being viewed as unaffordable for those in high-risk areas [e.g., Flood Re in the UK and discussions being held in Ireland per Surminski, 2017a].
From an actuarial and insurance economics standpoint, the insurability of natural disasters presents several challenges which have triggered a range of economic assessments, with several books and special issues devoted to the topic as it relates to flooding and other catastrophes. Examples are Zeckhauser (1996), Froot (1999), the Organisation for Economic Cooperation and Development (OECD) (2005), the Wharton Risk Management Center (2007), Kunreuther and Michel-Kerjan (2009), and Courbage and Stahel (2012). Risk layering is one approach developed to improve the insurability of disaster risks such as flooding through “the proportional division of the risk burden amongst interested parties … with each shouldering what each one is capable of bearing” (Makaudze, 2012). This is typically achieved through reinsurance, whereby an insurer will develop its own loss modeling and decide which losses to apportion to different parties (Grossi & Kunreuther, 2005).
The frequency and severity of floods are a major risk to the insurance industry because they can compromise insurability (Golnaraghi, Surminski, & Schanz, 2016). In particular, insured losses tend to be correlated when they arise due to natural disasters (e.g., a large number of policyholders being affected by a natural disaster due to its geographical spread); risk pools can lack the required size to cover such high loss events on a regular basis due to limited takeup [see Kunreuther & Pauly, 2004, and Ranger & Surminski, 2013 for an overview of demand factors]; and there can be a lack of quality data on natural disasters for insurers to effectively price risk. Furthermore, there is the challenge of asymmetrical information leading to adverse selection, with those at high risk more likely to buy insurance, which can threaten the economic viability of the program due to gaps between premiums received and claims paid (Huber, 2011).
Factors such as these can result in high insurance premiums, leading to affordability and accessibility issues. This situation can upset the “fine balance” between affordability and profitability for insurers (Collier et al., 2009; Surminski, 2017a). In extreme cases, insurers may even choose to leave unprofitable and overly risky markets altogether (Prudential Regulation Authority, 2015).
Research on flood insurability has benefited from industry-led assessments, most notably from the reinsurance industry and industry associations such as national trade bodies and the Geneva Association. Indeed, the industry itself has invested significant amounts in risk science, improving risk assessment and analytical approaches, often in close collaboration with the academic sector and international organizations such as UNISDR [see Golnaraghi et al., 2016 for an overview]. Across many flood insurance markets, there are signs that underwriting has become more technically oriented (Surminski et al., 2015). However, technical flood risk analysis is far from straightforward. Conducting risk analysis requires access to high-quality data with appropriate resolution (on hazards, assets, and their exposure and vulnerability), tools and models, and multidisciplinary technical expertise to develop, interpret, and understand the uncertainties associated with the analysis (Golnaraghi et al., 2016). Thus, there is also a danger of overestimating the risk assessment capacity of insurers. While many reinsurers have dedicated teams and technical experts, there is a clear lack of expertise and skills within many insurers. The industry relies heavily on commercial models, but whether this reliance drives commercial underwriting decisions is far from clear (Surminski, 2017b).
Regulatory requirements such as the European Union’s Solvency II directive have increased the need for technical risk assessment, but, as noted by Surminski (2017b), assessment is far from an exact science. The industry is mostly focused on risks over the 12-month policy coverage period rather than taking a longer-term look at trends. This problem is well-known, and it leads to a short-sighted reflection on current risks, with insurers knowing that they have the flexibility of changing terms and conditions every year should the risk profile change (Surminski, 2017a).
Flood Insurance as a Catalyst for Risk Reduction?
Driven by the scale of flood risk and the challenges that this presents for society, a growing body of academic literature is investigating how to align insurance and risk reduction. These efforts require contributions from a range of disciplines, which are all focused on certain elements of the interplay between vulnerability, exposure, and hazard trends, such as:
• engineering and hydrological sciences to improve understanding of the effectiveness of risk reduction efforts;
• physical science to investigate the influence of climate change on different flood hazards;
• insurance economics to improve understanding of moral hazards and assess innovative risk transfer measures;
• actuarial science to investigate loss probabilities;
• risk modelers to understand the impact of risk reduction efforts on changes in claims payments;
• ecology to investigate the role of nature-based flood risk management solutions;
• economics to explore the use of insurance for incentivizing those who can take action to reduce risks, and estimations of future losses;
• social science to understand how behavior, public policy, culture, and other factors determine the success of risk reduction efforts, while also investigating what role insurance can play influencing such a shift toward anticipatory risk reduction; and
• political science to investigate flood risk governance and the questions of compensation and prevention.
From 2000 on, disaster risk management science has started to embrace more and more of these different disciplines. The move toward an integrated flood risk management concept is underpinned by a growing understanding of flooding as a multifaceted phenomenon, no longer the domain of engineers, hydrologists, and statisticians (Merz et al., 2014). It requires a much broader definition of the risk concept, exploring the hazard alongside vulnerability and exposure, reflecting on behavioral aspects and assessing this in an integrated way (Bubeck, Aerts, de Moel, & Kreibich, 2016). The report given in Poljansek et al. (2017), produced by the European Union’s Disaster Risk Management Knowledge Centre, reflects on this. It documents an increasingly holistic approach to disaster risk management and aims to improve the integration of science into informed decision making, building on earlier literature (e.g., Southgate et al., 2013; Cutter et al., 2015). Evidence exists that this trend has led to a better understanding of the importance of risk reduction and of the role of flood insurance.
As an ex-ante instrument, flood insurance has clear advantages over post-event support in promoting a strategic, ex-ante approach to flood risk (Aerts & Botzen, 2011; Surminski, 2015). Flood insurance is speedier and more reliable in terms of payouts and can introduce a degree of anticipatory risk awareness and planning among individuals, businesses, and governments. It can also incentivize those at risk to reduce their vulnerability to flooding through, for example, adopting preventive measures (see Kunreuther, 1996; Kunreuther & Michel-Kerjan, 2009; Bräuninger et al., 2011; Aerts & Botzen, 2011). This can promote a more efficient use of financial resources in anticipation of flood events (Linnerooth-Bayer & Hochrainer-Stigler, 2015).
Risk-based pricing is also considered as an effective way to promote investment in risk reduction and settlement away from high-risk areas (Filatova, 2013; Kunreuther & Michel-Kerjan, 2009; Hanger et al., 2017). This perception is because risk-based pricing can communicate risk through pricing signals and therefore encourage policyholders to reduce their own risk in return for reduced premiums (Falco, Adinolfi, Bozzola, & Capitanio, 2014; Surminski, 2017a). The effectiveness of different measures can then theoretically be communicated through varying degrees of premium adjustment (Doherty, 1980). However, there remains the risk that policyholders may also be influenced by the “moral hazard” of insurance (i.e., the tendency to continue engaging in risky behavior because insurance compensates for the losses of that behavior), leading to maladaptation (O’Hare, White, & Connelly, 2015). Furthermore, charging risk-based premiums (and therefore promoting risk reduction through pricing signals) will become increasingly difficult as premiums become less affordable due to rising risk, suggesting new incentives will have to be provided for investment in risk reduction [e.g., voucher and mitigation programs per Kousky & Kunreuther, 2013].
In their study of flood insurance in Austria, England, and Romania, Hanger et al. (2017) conclude that households with flood insurance are more likely to have both “structural measures” and “avoidance and preparedness measures” in their homes. Having public support and information also had a positive correlation with uptake, a finding supported by Thieken et al. (2016) for Germany. However, Hanger et al. (2017) also suggests that households are less likely to adopt risk reduction measures if they are protected by public measures (e.g., dams) or are restricted by cost, indicating that the moral hazard associated with flood insurance may not stem from insurance alone, but its interaction with other external factors. Furthermore, Hanger et al. (2017) point to a lack of incentives by insurers to invest in risk reduction as having a detrimental effect. This assertion is supported by Lamond, Proverbs, and Hammond (2010), who show that insurers are not necessarily effective at encouraging homeowners to reduce their individual risk, despite being a key source of information for such policyholders.
Separately, insurance can promote resilient reinstatement of flooded properties following a disaster event in order to reduce future vulnerability, though the focus still tends to be on like-for-like replacement (Surminski & Eldridge, 2015).
The National Flood Insurance Program (NFIP) in the United States is an interesting case study in this respect. The NFIP seeks to promote risk reduction by only allowing communities to access flood insurance under the program (which is facilitated by private insurers) if they have adopted floodplain management ordinances that adhere to a certain minimum standard. Concerns exist, however, that this policy is not having the expected impact on risk reduction. For example, Starbuck (2016) notes that repetitive loss properties are still included in the program and have accounted for a consistent amount of losses. The use of grandfathered rates rather than risk-based premiums for certain high-risk properties also continues to disrupt the pricing signals that can promote investment in risk reduction (Starbuck, 2016). This situation highlights the difficulty of finding an appropriate balance between incentivizing flood risk reduction and keeping flood insurance affordable. Furthermore, only those homeowners who live in designated flood zones in participating communities and who have a federally backed mortgage are required to purchase flood insurance, with voluntary uptake of insurance from other homeowners remaining quite limited.
Perhaps most importantly, insurance can be a powerful framing tool through which substantial data assets on risk and risk reduction measures can be developed, and a number of such examples already exist, such as HORA in Austria (Stiefelmeyer & Hlatky, 2008) and ZURS in Germany (Kron, 2013). Here, the industry itself has engaged in better understanding and in improving the evidence base for risk reduction measures. One additional example is a report by Lloyd’s and RMS (2008), which demonstrates that building a home on an elevated platform between 0.5 meters and 1.5 meters could reduce losses due to flooding by 10% and 80% below present-day levels, respectively, even in the context of a sea level rise that would otherwise increase 1 in 200 year losses by 20%.
Integrating Flood Insurance and DRR Frameworks
Drawing on these underlying concepts, attempts are being made by policy makers and industry to strengthen the integration of flood insurance and risk reduction. Efforts at the international community level to achieve DRR began with the 1994 Yokohama Strategy and Plan of Action for a Safer World (Yokohama Strategy). Although the Yokohama Strategy acknowledged the need for participation at all levels to achieve prevention (e.g., local communities and the national government), it did not explicitly consider a role for insurance as a risk reduction instrument. The Hyogo Framework for Action 2005–2015 (Hyogo Framework) sought to address gaps in the Yokohama Strategy, including recognition of insurance in financing post-disaster recovery and rehabilitation.
More recently, the Sendai Framework for Disaster Risk Reduction (SFDRR) has called for integrated action by governments and other stakeholders (including the insurance industry), acknowleding the role of insurance in its quest to achieve greater disaster risk reduction:
30. To achieve this, it is important … (b) [T]o promote mechanisms for disaster risk transfer and insurance, risk-sharing and retention and financial protection, as appropriate, for both public and private investment in order to reduce the financial impact of disasters on Governments and societies, in urban and rural areas. Importantly, no link is otherwise made regarding how insurance can promote risk reduction.
In the 2012 Sendai Report (which informed dialogue around the SFDRR), five pillars were identified as central to achieving integrated disaster risk management: risk identification, risk reduction, preparedness, financial protection, and resilient reconstruction (see Figure 2). Unlike the SFDRR, the 2012 Sendai Report explicitly recognizes the role of insurance in encouraging risk reduction by putting a price on risk.
These references to linkages between flood insurance and risk reduction are relatively basic, but efforts have been made to undertake a more nuanced analysis. For example, the European Union Green Paper on the insurance of natural and man-made disasters (2013) called for consultation on how insurance could contribute to risk reduction by providing a market-based incentive for investment in risk reduction measures; in particular, through price signaling. It also places significant focus on the ability of insurance to spread the risk of flooding across society. In its recent Action Plan on the Sendai Framework (European Union, 2016), it was noted that a high-level round table would be held with the insurance sector to discuss how insurance could promote risk reduction.
Importantly, the different pillars of flood risk management continue being considered separately, not complementarily (Golnaraghi et al., 2016). This point is very important in the quest for a truly holistic and forward-looking flood risk management strategy that considers the variety of risk drivers, response options and impacts:
The move towards anticipatory FRM [flood risk management] is underpinned by a growing understanding of flooding as a multi-faceted phenomenon that requires a broad array of such measures, which extend beyond the domain of engineers, hydrologists and statisticians (Merz et al., 2014). It requires a much broader definition of risk, exploring the hazard alongside vulnerability and exposure, reflecting on future trends and behavioral aspects, and assessing this in an integrated way (Bubeck et al., 2016)”; (Surminski & Thieken, 2017). This has also been underlined by Aerts et al. (2018), who call for greater recognition of the human behavior factors that influence risks.
Recent Science Contributions in Support of Greater Alignment of Flood Insurance and Risk Reduction
Against this backdrop of a lack of alignment between flood insurance and risk reduction, a clear need exists for further evidence and decision support for those making flood risk- and insurance-related decisions. Recent academic contributions expand the understanding of the benefits of greater integration, provide insights into the challenges to achieving this, and indicate the limitations of current flood insurance regimes. Some of the key strands are outlined here; however, this list is not exhaustive and the area is evolving.
Improvements in Risk Assessment and Greater Alignment in Modeling to Increase Understanding of Risks and Risk Reduction Efforts
Data and tools are required to understand the potential for flood impacts as well as the benefits in terms of reduced impacts. In general terms, natural disaster risk assessments can be done either through statistical risk assessments or catastrophe models (Embrechts, Klüppelberg, & Mikosch, 1997). A challenge with the statistical approach is that often few long historical records exist of low-probability/high-impact natural disaster risks, and these records may not be an appropriate indicator of assessing risks that are increasing over time due to factors such as climate change. Because of these challenges, catastrophe models are a commonly used alternative method. Catastrophe models are computer-based models that estimate the loss potential of natural disasters (Grossi & Kunreuther, 2005). From the early 2000s forward, these models have emerged from singular usage by insurance companies toward a broader application of informing risk management (see Michel-Kerjan et al., 2013).
Advancements in geophysical sciences combined with innovation in numerical modeling and computing have enabled the development of finer-resolution global weather and (increasingly) climate models and forecasting tools, providing essential input for forward-looking risk analysis to support the development of sound risk management strategies (Golnaraghi et al., 2016).2
More recently, there have been efforts to align these with climate change projections (Feser, Rockel, von Storch, Winterfeldt, & Zahn, 2011); however, these efforts continue to be difficult [see Intergovernmental Panel on Climate Change (2014) and Botzen et al. (2015) for an overview]. As an example, Jongman et al. (2014) investigate how flood losses in Europe may develop in the future as a result of climate and socioeconomic change. Their model results show that current average annual flood risk is about €5 billion, which may increase up to €24 billion by 2050 because of these factors.
Alfieri et al. (2017) demonstrate how increases in global warming (particularly if global warming continues on a 4 °C warming pathway) could lead to increases in flood risk in excess of 500% for countries representing more than 70% of the global population. Similarly, sea level rises of just 2.5 cm will double the risk of flooding for a number of coastal areas globally, including many that are already significantly vulnerable such as small island developing states (Carrington, 2017; discussing research conducted by Vitousek et al., 2017). In Europe, flooding costs have the potential to rise from €4.2 billion annually in 2012 to €23.5 billion annually by 2020 (Jongman et al., 2014). Hallegatte, Green, Nicholls, and Corfee-Morlot (2013) estimate losses in cities of USD$52 billion by 2050 due to socioeconomic changes alone.
A range of studies reflect on the role of climate change and other risk drivers in the context of insurability, affordability, and availability of flood insurance, such as Botzen (2013), Aerts and Botzen (2011), Jenkins et al. (2017), and Dixon et al. (2017). For example, Aerts and Botzen (2011) demonstrate how climate change, based on certain assumptions, may require a premium increase of from 641% to 797% by 2100 to cope with the impacts of climate change on flooding probability. This projection is further complicated by the fact that climate change is not clearly understood (Jotzo, 2010), providing an additional layer of uncertainty to required premium level increases.
Incentivizing Risk Reduction
While literature agrees that flood insurance can in theory work as a market-based incentive for risk reduction, the evidence of flood insurance actually providing this incentive has been inconsistent (Botzen & van den Bergh, 2009; Mills, 2009; Surminski et al., 2015). Recent studies have shed more light on this dynamic, particularly in the context of risk-based pricing, where insurance premiums are used as a signal of risk levels (Surminski & Hudson, 2017).
One example is a survey by Bukvic, Smith, and Zhang (2015) investigating the determinants of relocation decisions of householders, which found that an increase in insurance rates (along with the potential recurrence of flooding) would provide a major incentive to relocate and suggests that risk-based insurance premiums could play a role in encouraging land use controls in flood-prone areas (as long as households are forced to or choose to remain insured) (see OECD, 2005).
Another example is a study undertaken by Hudson, Botzen, Feyen, and Aerts (2016) examining flood insurance in France and Germany, which concludes that risk-based pricing could lead to a significant reduction in risk for both countries by 2040 (12% in Germany and 24% in France). Similarly, Haer, Botzen, de Moel, and Aerts (2016) in Heijplaat, Rotterdam note that the implementation of risk reduction measures by households also increases when insurance premium discounts are offered for doing so. Adopting their own agent-based modeling (ABM), Haer et al. (2016) modeled household behavior based on (1) whether there is an incentive to invest in risk reduction, and (2) the applications of a range of behavioral theories assumptions (e.g., the theory that individuals will adopt an approach with the highest expected utility). Through this analysis, it can be argued that providing an insurance premium discount could lead to a one-third decrease in flood risk. Whether it does so, however, will also depend on household behavior, which is discussed in “Behavioral Aspects Relating to Flood Insurance and Risk Reduction.”
Furthermore, risk-based pricing raises its own gamut of affordability and social justice concerns; what if a household cannot afford to invest in risk reduction measures? This question suggests a further range of incentives might be needed.
Identifying the Benefits of Risk Reduction Measures and Their Relationship With Flood Insurance
Generally, the influence of risk-based pricing as a means of encouraging risk reduction is not only challenged through concerns about affordability, but also tempered by the fact that insurers do not always know how to quantify the benefits of different measures, or indeed, whether those benefits exist at all, for example in the context of non-structural flood protection measures (DEFRA, 2016). Improving the quantification of different risk reduction measures may therefore improve the role of flood insurance as a market-based incentive. At a more preliminary level, demonstrating the effectiveness of different risk reduction measures may also temper the moral hazard of insurance.
Jenkins et al. (2017) have recently applied an ABM to analyze the relationship between different resilience measures and flood insurance, helping to verify what measures work and what role flood insurance can play in encouraging their implementation. The ABM was tested for a specific area of London and related to its surface water level risk. Models were created using different combinations of flood risk management options, including different structural measures such as sustainable drainage systems (SUDS) and property level protection measures (PLPMs). Importantly, it is suggested that the ABM is transferable to other regions.
The analysis conducted by Jenkins et al. (2017) demonstrates that investment in SUDS and PLPMs results in reduced premiums (using Flood Re in the United Kingdom, a new reinsurance pool that allows insurers to reinsure high-risk policies at a highly subsidized price, as an example). Equally important, Jenkins et al. (2017) show that insurance alone does not result in a decline in risk: Although insurance may transfer risk, it does not mitigate it despite evidence from some countries that the willingness of insurers to consider PLPMs in the terms and conditions of insurance policies has increased [see Deutsches Komitee Katastrophenvorsorge (DKKV), 2015]. However, the analysis by Jenkins et al. (2017) does suggest that the benefits of measures such as SUDS and PLPMs can be outweighed if development continues in high-risk areas. This point highlights the need to involve a broad range of stakeholders who can provide a more holistic solution to mitigating flood risk.
Jenkins et al. (2017) also show that investment in risk reduction means less need for government intervention in insurance markets. This conclusion is reflected in the declining number of insurance policies that would need to be insured with Flood Re over time where there is investment in risk reduction.
Behavioral Aspects Relating to Flood Insurance and Risk Reduction
Achieving flood risk reduction depends on the behavior of those at risk or those in charge of managing risks. Perhaps the most important lesson that can be drawn from Haer et al. (2016) is that the adaptive behavior of households is uncertain, particularly in light of a quickly changing risk environment. There are no empirically proven decision models that can be applied to household behavior [explaining the use of four different models by Haer et al., 2016], and it may be the case that other stakeholders make decisions based on other models of decision making. This situation creates an additional element of uncertainty. Is the failure to adopt risk reduction measures related to the failure of flood insurance to adequately incentivize their adoption, or are there broader consumer behavior issues (e.g., affordability or underestimation of risk)? The Property Flood Resilience Action Plan (DEFRA, 2016) has recently suggested that property owners may underestimate or deny their flooding risk, but it is unclear which factors are most at play since they occur on an individual level.
Jenkins et al. (2017) complement this in their ABM study by concluding that incentives for adopting risk reduction measures need to be targeted toward those stakeholders who are capable of taking action; in particular, developers, mortgage providers, and local planning officials. This conclusion was reached by including six stakeholder types (people, houses, an insurer, a bank, a developer, and a local government) in the ABM study. The key question then becomes: “Which of these stakeholders can flood insurance target to promote risk reduction?” How flood insurance could foster risk reduction by such stakeholders remains unclear. Furthermore, it may be the case that some stakeholders have incentives to pursue risky developments. For example, while mortgage providers have an interest in reducing the vulnerability of projects they finance, developers and local government officials may face competing pressures such as reducing costs or increasing available housing, thus prompting development in high-risk areas. Furthermore, the recently imposed requirement on certain new developments to include SUDS in the UK has failed to mitigate flood risk, suggesting resilient development is not enough; in addition, development needs to be adequately discouraged in floodplains (Jenkins et al., 2017).
Figure 5 presents the broad range of stakeholders that are involved in the value chain for new properties, indicating where in the process decisions are made and by whom. In their absence, it is practically impossible to achieve integrated flood risk management.
Perhaps the key lesson that can be drawn from this analysis is that flood insurance, and its ability to promote risk reduction, depends on the integration of a broad range of stakeholders who can take decisions on flood risk. The need to engage a range of stakeholders and the limited ability of flood insurance to produce a decline in risk in isolation lends support to the need for an integrated approach to flood risk management that incorporates a range of stakeholders (e.g., different levels of government and developers) and therefore a more holistic approach to addressing risk. However, insurers do not necessarily appear to support this view. During interviews conducted by Surminski et al. (2015), commented on lack of co-operation between industry and other stakeholders, with some arguing that risk reduction is primarily a role for the state. Similarly, insurers in Ireland have criticized the government for (in their view) failing to make sufficient investment in flood defenses (thejournal.ie, 2016).
Science Informing Practice: Toward the Integration of Flood Insurance and Risk Reduction?
The scientific understanding of risk reduction and flood insurance continues to develop, spurred by concerns about rising risks and the threats that these pose to insurability from policy makers and insurers.
However, there is limited evidence of this understanding being translated into practice in encouraging risk-reducing behavior (Thieken, Petrow, Kreibich, & Merz, 2006; Treby, Clark, & Priest, 2006; Crichton, 2008; Botzen et al., 2009; Lamond et al., 2010; McAneney et al., 2013; Surminski et al., 2015; Hanger et al., 2017). Indeed, insurers themselves admit that achieving flood resilience is a challenge and that more collaboration between the public and private sectors and science will be needed to make progress toward a truly integrated approach to flood risk management (see, e.g., ClimateWise, 2016). For example, the Geneva Association, the leading international think tank of the insurance industry, has recently identified the need for an integrated approach to flood risk management that brings together a broad range of stakeholders (including government and the insurance industry) across four key areas: risk assessment, risk reduction, financial protection, and resilience building (Golnaraghi et al., 2016) (see Figure 6).
In this context, flood insurance is seen as a critical risk management tool for addressing increasing flooding risk. It can be used for (1) signaling to policyholders their individual risk to flooding, improving knowledge of the level and type of risk, (2) underwriting and redistributing the costs of risks globally, and (3) improving knowledge of risk management and disaster risk reduction (Golnaraghi et al., 2016).
However, in practice, most flood insurance mechanisms are not designed with risk reduction in mind, stymying their ability to cope with rising losses (Surminski et al., 2015).
Where recent discussions have focused on the long-term viability of flood insurance (e.g., regarding the adoption of Flood Re in the UK), they have often failed to adequately address the role of flood insurance in achieving risk reduction. For example, Flood Re provides no incentive for risk reduction, calling into question its ability to secure long-term affordability (e.g., Alexander et al., 2016; Surminski & Eldridge, 2015).
Reflecting on recent developments in science and practice, there are several areas where research can help to address these shortcomings, building on the recent developments discussed in this article.
The first area is the use of risk data and risk assessment. Lack of quality data, untransparent models, and limited reflection on behavioral aspects all limit its usability for risk reduction. A number of countries have implemented innovative approaches for improving risk assessment and data sharing [see Surminski, 2017b, for an overview], and many of these international examples show some degree of collaboration with industry and science in order to develop underlying risk data and modeling capacity:
However, these approaches are often limited in their application. For most it is unclear how and to what effect they are used in decision-making. Another limitation appears to be a relatively narrow focus on the insurance industry and government, with the role of other sectors and stakeholders in gathering and using the data receiving little consideration. Recent efforts in Scandinavian countries, driven by municipal governments worried about lack of insurance in their cities, are attempting such a broader approach, bringing together all the key sectors whose decisions influence risk levels and using the data to inform development, house buying, infrastructure planning and public budgeting.
Another area is innovation of business practices. Incorporating flood resilience into decision making is a challenge for insurers. Innovative products and services will be necessary if flood insurance is to remain a viable option. Flood Re in the UK is a rare example of such a new approach; however, it lacks a focus on risk reduction. Other, possibly more promising innovations can be seen in developing countries, with the emergence of parametric insurance solutions and microinsurance schemes as well as sovereign risk-level schemes. While the risk reduction impact still remains doubtful, there are some efforts underway to test and try new approaches for linking risk transfer and risk reduction (Surminski & Oramas-Dorta, 2014; Schaefer & Waters, 2016). Some of these concepts may also help address the issues in established markets. One idea that may be revived is that of mutual insurance, where there is a greater degree of risk ownership across the group of insured, who also “own” their insurance mechanism. Another example is parametric flood insurance schemes for community-based insurance, as recently proposed by Kousky and Shabman (2015). Further research and testing will be needed.
A third area worth mentioning is the role of nature-based solutions for risk reduction. Ecosystems can reduce flood risks, for example by regulating water or by providing coastal protection through mangrove forests. These services are often not considered when making decisions about land-use or infrastructure development, while the protection and enhancement of these services are difficult: The return on investment may take many years to manifest or may not exist for individual investors due to the public good nature of these services. This area is of growing interest to policy makers and insurers, as indicated by a recent European Commission Horizon 2020 research call on the topic, where scientific input will be needed in order to develop incentives for greater protection and investment into these nature-based solutions.
For insurers, there are also opportunities to recognize risk and risk reduction as part of their investment processes (e.g., in infrastructure or property), which often do not consider flood risk in their appraisals or assume that insurance will take care of the risk (ClimateWise, 2016). This has been identified by the Bank of England as a potentially systemic risk, with institutional investors creating new risks that the insurance industry may be unable to cover in the future (Prudential Regulation Authority, 2015). Science can create an improved understanding of the causal chains related to these investment processes and point out where risk reduction and investment or risk transfer decisions can best be interlinked.
Finally, there is a need for greater integration of behavioral aspects when assessing risks. Vulnerability and exposure are influenced by the behavior of individuals, businesses, and governments. Any efforts to change behavior, be it through incentives or public policies, need to understand the factors that drive behavior. Research in this area is still under development, but recent applications with agent-based modeling (ABMs), as outlined in the sections “Identifying the Benefits of Risk Reduction Measures and Their Relationship with Flood Insurance” and “Behavioral Aspects Relating to Flood Insurance and Risk Reduction,” are promising efforts. These applications underline the need for truly multidisciplinary approaches to risk assessment, where risk-reducing behavior can be modeled and the implications on risk levels assessed. This point was recently highlighted by the UK Climate Change Risk Assessment, which is explicitly designed to inform public policy and identify those areas where adaptation action is deemed most important (Adaptation Sub-Committee, 2016). Understanding the interactions between risk reduction behavior and how vulnerability and exposure can change over time is an important component of assessing risks and designing response mechanisms (Di Baldassarre et al., 2015; Dawson, Peppe, & Wang, 2011).
In conclusion, scientific evidence shows that the only truly sustainable response to flooding and climate change is a significant increase in efforts to reduce the underlying risks and influence risk drivers. This in turn can help to secure affordability and availability of flood insurance, a cobenefit of risk reduction. Risk reduction, however, reaches far beyond those who are insured and those who provide insurance: It can also address the intangible effects of flooding such as emotional stress, health issues, and economic competitiveness of communities and regions.
Dr. Swenja Surminski would like to acknowledge the financial support of Ireland's Environmental Protection Agency (EPA) under the EPA Research Programme 2014–2020, of the UK Economic and Social Research Council (ESRC) through the Centre for Climate Change Economics and Policy, and of the Grantham Foundation for the Protection of the Environment through the Grantham Research Institute on Climate Change and the Environment. The author thanks Joel Hankinson for his input and assistance.
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(1.) This article focuses on flood insurance in developed markets such as the Organisation for Economic Cooperation and Development (OECD), but it is important to highlight that there is a significant amount of new research being conducted focusing on innovative ways for climate insurance, including coverage against flooding, to be integrated in adaptation and climate risk management strategies in developing countries. This research is against the backdrop of a significant lack of insurance coverage across most developing countries, which has been termed the “protection gap” and is receiving growing attention from the insurance industry and development agencies.
(2.) Theses has been facilitated under internationally coordinated climate and weather research programs such as World Climate Research Program (WCRP) and World Weather Research Program (WWRP), and the International Research on Disaster Risk (IRDR), engaging thousands of scientists from academia, research labs, and centers of excellence from around the world. Coordinated research carried out under these programs underpin the IPCCC Assessment reports. These programs can be leveraged for strengthening of multidisciplinary approaches to harness the best of science to understand the impacts of climate variability and change on society.