3.5 CLIMATE CHANGE THE NEXT SECTION DISCUSSES WHY CLIMATE CHANGE...

8.3.5  Climate  Change  

The next section discusses why climate change should not be used as a condition to justify the

introduction of private flood insurance to the Netherlands. Most academic papers on flood insurance,

including this one, begin with a reference to climate change and the anticipated resultant increase in

flooding. In that vein, Botzen and van den Bergh (2008) constructed their justification for the

introduction of multi-level public private flood insurance in the Netherlands by citing recent IPCC reports

concerning the likelihood of sea level rises, increased storm surges and more precipitation in the future.

While this is not an unreasonable argument in countries that have minimal flood defenses, this is

generally not the situation in the Netherlands. Their paper makes little reference to the extent the

Netherlands has successfully adapted to manage current and predicted future flood risk. While there is

of course a calculable probability of a serious flood in the Netherlands, if it is accepted that the Dutch

flood defenses have been built to agreed safety standards, the probabilities are much lower than in

other less well defended countries. This raises two current challenges and one future problem for

private insurers entering the Dutch market for flood insurance.

First, flood risk related to future climate change is very difficult to assess (being low probability and high

impact). If climate change is taken into account by private insurers, it translates into insurance

premiums priced much higher than probability alone would dictate. Private insurance companies

operate in a world of imperfect information. If they are asked to insure climate change risk, it is still

necessary that, as private insurance companies, they make a sufficient yearly return to justify taking on

an unknown and open-ended risk. If probabilities are very low it is very difficult to persuade an

underwriter to take on that risk. Underwriters prefer more known risks such as fire hazard, which follow

a more predictable pattern. It allows them to build such future losses into their models. They will not ‘bet

the house’ for only a small fee (EP, 2013). Private insurance companies are not well equipped to

assess uncertain future risk. Their expertise is in assessing current or near term risk. Pricing of flood

insurance to include future climate change risks is very difficult and an area of risk modelling that

insurance companies are not adept at. If or when flooding becomes a more frequent event, private

insurance companies may assume greater importance as organisers for sharing mutual risk.

Second, flood insurance is only taken out if there is an expectation, however small, that in the next year

a flood might occur. Policyholders get no financial return or extra protection by buying flood insurance

cover years in advance of an anticipated threat. However well meaning, paying an insurance company

does not reduce the risk from climate change. It would make more sense for an individual to spend the

money on investments to reduce their own personal risk - protection from flood proofing a house will not

cease when payments stop. Or through paying into a fund for collective flood protection. The latter is

essentially the case in the Netherlands today. Indeed from a national perspective it would be more

economically efficient and socially equitable if money were spent improving flood defences in line with

climate change predictions rather than repeatedly paying private insurance companies each year to

cover potential losses resulting from a flood that should never happen . Add to this the promise of

government compensation through the WTS in case of flooding using climate change is therefore not a

good reason or a condition the entry of private insurance into the Netherlands.

Third, if climate change increases flood probabilities beyond a certain point, it may become unprofitable

to offer flood insurance (Botzen, 2010). Private insurers will only be interested in continuing to sell flood

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insurance while they can make a sufficient return. While many say climate change offers new

opportunities for businesses, this is true for insurance companies only up to the point when flood

incidents become too numerous or costly to insure commercially. This was the industry’s response after

the last great floods in 1953 and would likely be the same if the Netherlands were hit by another huge

storm leading to widespread and costly flooding. Sustaining private natural disaster insurance models is

very difficult after a serious event. First, premiums will rise, which will reduce demand. Secondly, most

often governments will have to step in to compensate uninsured losses in order to speed-up overall

recovery times (Paudel 2012; Jongejan and Barrieu, 2008). This phenomenon combined with higher

premium will act as a disincentive for individuals to renew their next insurance policy. Private insurance

of large flood events without government backing does not work (Paudel, 2012). The NAT/CAT works

because private companies retain a small layer of risk; the rest is reinsured by the state. In the Belgian

WN, the exposure by private insurance companies is very small relative to potential losses. The UK

system is breaking down because insurance premiums are rising unsustainably - hence the need by

private industry for the ‘Flood Re’ insurance pool. ‘Flood Re’ is as much about offering affordable flood

insurance to high-risk homeowners as it is about insurance companies transferring unprofitable flood

insurance policies to a state backed company (EP, 2013).