Into the Pool!
OpinionOpinion piece by ZEW President Achim Wambach and Clemens Muth
Extreme weather events are on the rise and the risks to properties are increasing. Nevertheless, only around 54 per cent of residential buildings in Germany are comprehensively insured against natural hazards – often due to a lack of risk awareness or high premiums. A new concept aims to make insurance cover in high-risk areas affordable through state-supported premium caps and a risk pool. In a guest article for WirtschaftsWoche, Clemens Muth (consultant, former Ergo board member) and ZEW President Achim Wambach explain how such a solution can be effective – and what should be the state's future role in managing natural hazards.
The consequences of climate change are increasingly felt in Germany. We are experiencing more ‘hot’ days, more torrential rainfall and more hurricanes. Yet public awareness of the need for better protection is rising only gradually. It is true that the German Climate Adaptation Act (Klimaanpassungsgesetz) came into force in 2024, requiring the federal and state governments to develop and implement adaptation strategies. Many local authorities have also begun to better prepare for the impacts of the rise in temperatures. However, the measures are not always sufficient or effective: Not infrequently, dike extensions are followed by zoning areas nearby as development land – thus increasing exposure to natural hazards.
Private households, too, must be better prepared for extreme weather events. This is in their own best interests because while general policies for protection against the consequences of climate change can be considered a public good, climate adaptation measures are private goods. Those who improve the protection of their homes against torrential rain reduce the potential damage they suffer. An essential aspect here is insurance cover against natural disasters. Insurance premiums send an important price signal about the risks to real estate from natural hazards. Construction methods and preventive measures can make insurance cheaper, while a lack of prevention increases premiums.
The problem is that only around 54 per cent (as of 2022) of private residential buildings are insured against all natural hazards. For some homeowners, insurance is too expensive – especially for those living in high-risk areas. Some households possibly assume that the public sector will help in the event of damage. In addition, many overestimate their own insurance cover: According to a study conducted by ZEW, around one in four respondents mistakenly believes that they are insured against natural disasters.
In order to provide affordable insurance cover against natural hazards even in high-risk areas, we propose a new insurance product. It consists of a premium cap for existing buildings and is combined with a special risk pool which is government-guaranteed.
The concept in detail: Owners of existing buildings can take out a basic insurance policy through a private insurer that covers 80 per cent of natural hazard damage. The remaining 20 per cent are a deductible paid by the household. The private insurer calculates the premium normally required, for example for a house in the Ahr valley, were a flooding disaster occurred in 2021 (e.g. a premium of 2,000 euros). The premium to be paid by the customer is made up of two parts: One part consists of 20 per cent of the actual premium determined by the insurer (400 euros in the example), and the other part is equal to 80 per cent of a capped premium, which depends on the average premium of the previous year and the cap set by the legislator. Ultimately, in the example of the high-risk area, the costs for the customer could be 1,200 euros instead of the 2,000 euros normally required.
Private insurers can reinsure up to 80 per cent of their risks in the risk pool. In years with few claims, the pool generates a profit; in years with many claims, it generates a loss. Due to the capped premium, a shortfall is to be expected over the years, which the state would have to compensate. Part of this exposure in the risk pool could be covered by the private insurance industry.
No more state aid for severe weather
Private households in high-risk areas in particular will thus gain access to affordable basic insurance cover against natural hazards. For the more than 99 per cent of existing buildings in less risky areas, the competitive private insurance market would continue to offer protection.
New buildings on undeveloped land that are approved from the date the risk pool is effective would not have access to the pool and premium cap. This ensures that the price signals from insurers for natural hazards can take their full effect: The corresponding costs, which are also caused by climate change, should be taken into account when rezoning land.
Yet, doesn't this concept harbour incalculable financial risks for the state? In fact, it doesn’t. The public sector would finance the risk pool instead of assuming a share of the costs of repairing severe weather damage in the private sector as it has done up to now. The population needs to be informed in a transparent manner that the state will not make any direct payments to homeowners in the event of a disaster beyond the funds paid into the risk pool. This approach would keep insurance for existing buildings in high-risk areas affordable without affecting premiums across the market.
This article was first published in WirtschaftsWoche (in German).
