The Role of Natural Disaster Insurance in Recovery and Risk Reduction

May 7, 2019

Carolyn Kousky

Natural disaster losses have escalated over the last several decades due both to continued building in high-risk areas and due to climate changes that are altering extreme events around the globe. As climate change continues to influence extreme events, the role of insurance in adapting to these changes is becoming an increasingly important topic.

In theory, insurance has a critical role to play in promoting disaster resilience. It can provide financial protection to insureds, preventing negative economic hardship after a disaster. It can speed rebuilding and recovery by providing post-disaster funding and liquidity soon after the event. Insurance could also help promote risk reduction before a disaster through financial incentives or after an event through extra funding for hazard mitigation incorporated into rebuilding efforts.

Insurance can only deliver on these benefits, however, in a broader landscape of risk management, supported by governments and other stakeholders. An understanding of the hazard risks and exposure, as well as an appreciation of the role of insurance, are all needed to realize this potential.

I recently reviewed the empirical literature on natural disaster insurance to answer the following questions:

  1. How are natural disaster insurance markets currently functioning?
  2. What is the role of natural disaster insurance in recovery?
  3. What are the impacts of disaster insurance on incentives for ex ante hazard mitigation and land use?

A central finding of the review, forthcoming in the Annual Review of Resource Economics, is that empirical papers cleanly identifying the relationships between insurance and recovery and mitigation outcomes are surprisingly limited.  More well-designed research is needed to isolate and quantify the differential impacts among insured and uninsured on a variety of measures.

The largest number of studies have been done on the role of insurance in disaster recovery. These have used multiple methods, though most have been surveys. This body of research generally finds that having insurance increases the likelihood of rebuilding, minimizes financial hardship post-disaster, and speeds time to recovery. That said, some of this work suffers from limited external validity, inability to identify causal relationships, or lack of quantification.

These studies also present varying degrees of evidence that certain lower income or minority populations are less likely to be protected by insurance and as a result may have worse recovery outcomes. This raises the troubling finding that those most in need post-disaster are least likely to have access to needed funds through insurance.

There are fewer studies examining the role of insurance on ex ante risk reduction. While a number of companies and programs offer premium discounts for hazard mitigation investments, there has not been an evaluation of whether these induce new mitigation investments or examining the role they play in consumer decision making. There is some evidence that any impact may be modest, suggesting that more careful work on this topic is needed. Although property values clearly capitalize disaster risk and/or insurance costs, there is little support for the claim that the availability of insurance has altered land-use patterns substantially—at historic price levels. Much more research is needed on the links between risk transfer and risk reduction.

As climate change alters extreme event risk around the globe, a deeper appreciation of the role insurance can play in climate adaptation will be required. Beyond the need for further isolation of the impact of having insurance on outcomes, there is also a need for research comparing the impact of various insurance designs and other mechanisms for funding disaster losses on recovery metrics and on the distribution of who bears the cost of disasters. Finally, in other areas, insurers have played a role in developing a culture of safety, in promoting preparedness measures, and in facilitating widespread adoption of risk-reduction measures. Careful work on when, whether, and how the insurance industry could help accelerate adoption of cost-effective hazard mitigation measures for changing disaster risk will become increasingly useful.

Read the full paper here.