2.2.2 Mandatory or Voluntary Status
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To identify the functional components, a broad analysis based on research from Paudel (2012) is used to help understand
the general and technical components of a flood insurance system. Second, to focus in on the question of private sector
involvement in flood compensation, a public-private classification by Swiss Re (2012) will be used. Following this, a more in-
depth analysis based on work by Jongejan and Barrieu (2008) is detailed to reveal the different types of public and private
involvement commonly found. Finally, a classification by O’Neill and O’Neill (2012) based on the principle of social justice in
flood insurance is used to contribute a social welfare perspective to the research question.
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Participation by individuals and businesses in a national flood insurance system is voluntary or
mandatory or quasi-mandatory. A compulsory system overcomes three challenges of providing flood
insurance. First, the cognitive difficulty people have to calculate accurately their own flood risk is
reduced
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because a mandatory scheme removes the need for individual choice. Second, a compulsory
system also overcomes the problem of adverse selection i.e. those who do feel the threat of flood are
the only ones purchasing insurance which has the effect of driving up insurance premiums for all? Third,
compulsory flood insurance ensures high market penetration and a large pool of insured properties
which increases financial viability of the system. Furthermore, the problem of free riding is lower under a
compulsory system as the risk is spread across the whole population, not just those who directly benefit
from the insurance. Overall, in a compulsory system reliance on ex-post government compensation is
consequently lower than in a voluntary system because all households will have some level of flood
insurance. This serves to increases economic efficiency as recovery times post flood will be faster under
mandatory systems compared to a voluntary one. Uninsured losses either have to be paid for the by the
state or can act as a drag on economic recovery if individuals are unable to pay, which reduces the
economic efficiency of the flood insurance system and decreases social welfare.
A compulsory flood insurance system can be achieved in several ways: flood insurance can be bundled
with other mandatory insurances; the government can legally oblige insurance companies to provide
cover; the state can make it quasi-mandatory for people to take out flood cover by insisting it is
purchased with other financial products such as mortgages. Product bundling with so-called ‘simple risks’
such as household fire insurance is a method to extend flood insurance coverage. Mandatory bundling is,
however, not always appropriate as it can infringe competition rules at the national and EU level.
Product bundling is also quite restrictive and may involve legitimacy issues if policyholders are not
consulted or given a choice to opt in or out, nor a choice of products.
Whether an insurance system is mandatory or voluntary is an influential component in the functioning of
national flood insurance systems and is therefore analysed in detail during this thesis. It is highly
correlated with the next attribute: market penetration.
