In the Aftermath of Dresden: New Directions in German Flood Insurance

The German flood disaster of summer 2002 highlighted a dilemma concerning insurance against damages caused by natural forces. On the one hand, mindful of the rising incidence of natural disasters, private insurance companies are increasingly withdrawing coverage against natural catastrophes such as wind storms and floods. On the other, the availability of emergency relief and private donations is systematically weakening the incentive for potential victims to implement preventive measures so as to reduce the risk of damages. The dilemma is further exacerbated by the evident overestimation of the extent of damages in the immediate aftermath of natural disasters, resulting in the unnecessary withdrawal of private demand and the ad hoc reprogramming of public investment. Most of these problems could be resolved by the introduction of a general mandatory insurance against natural catastrophes. This paper proposes a practicable natural hazard insurance for Germany that is based on two principles. First, all basic natural disasters (wind storms, floods, earthquakes, etc.) would be covered by a single policy. This pooling approach would increase both the efficiency of risk coverage and the level of acceptance for the new type of insurance. Second, in the case of floods, only "once-a-century" damages would be insured. Regularly recurring floods, however, would not be covered. The state would step in as the final insurer in cases of accumulating damages, but state intervention would be strictly limited to covering extreme loss.