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How do you insure yourself against climate change?

  • July 21, 2021

Many people in Germany were blindsided by the heavy rains and deadly flooding that hit parts of the country in mid-July. Now, as homeowners take stock of the damage, a second shock could be in store when they take a look at their insurance policies. 

Homeowner’s insurance in Germany covers water damage, but not if it’s caused by heavy rains or natural flooding. For this, property owners need to purchase special coverage against weather damage.

Such caveats, which aren’t exclusive to Germany, pose problems in a world where unpredictable weather is becoming the norm. Higher global temperatures can lead to increased precipitation, making floods more likely, according to the United Nations Environment Programme.

Insurance against severe weather is an “urgently needed” addition to standard homeowner’s insurance, Sascha Straub, a finance lawyer working for a consumer consultancy in Bavaria, told DW.

“The damage that water can cause is so immense that it can ultimately be a complete economic disaster for the individual,” said Straub. “And now we see the likelihood that it will also affect those who haven’t had to reckon with water before.”

The cost of this supplementary coverage varies by location and type of property, says Straub, and can range between 30% of your standard homeowner’s insurance policy all the way up to 300% for the most at-risk properties. Less than half of insurance holders in Germany have currently opted in for this extra coverage.

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    The flood completely destroyed Jutta Schelleckes’ apartment. She and her injured husband had been living in the mess for two days before firefighters arrived and decided to escort them out of their apartment and help them find shelter. Jutta is only one of the thousands of citizens whose homes have become uninhabitable.

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    Racing against time

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    Tons of waste and garbage to be removed

    With volunteers’ help, residents have started to clean up their battered homes and shops. Garbage trucks drive back and forth to remove the aftermath’s waste from the streets. In Trier, one of the severely affected regions, 14,000 tons of flood waste was collected during the weekend, the spokesperson of the region’s waste management association told public broadcaster SWR.

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    Solidarity comes to the rescue

    In addition to an army of volunteers in disaster zones, countless solidarity initiatives were created to collect donations. The flow of donations quickly became overwhelming, to the extent that several aid organizations announced they have no more capacity to receive more donations. While the COVID pandemic has kept people apart, the disaster has brought communities in the region together.

    Author: Monir Ghaedi

Who should foot the bill?

Not everyone is ready to eat this cost, especially those who might need it most. 

“Insurance becomes less attractive for high-risk households or farmers when premiums reflect the underlying risk,” the European Commission wrote in a 2018 report on insurance and climate change. “Although lower-risk policyholders have a weaker incentive to reduce risk, they are more likely to buy insurance since premiums are more affordable.”

Some would rather take the chance. In the event of a natural catastrophe, the state can also be expected to jump in. The German government has already promised swift aid to those affected by the floods.

But even with federal aid on the table, not having the right insurance might still pose problems. In Bavaria, for example, only people who can prove that they tried and failed to get coverage can receive aid from the state, according to a report in the newspaper Frankfurter Allgemeine Zeitung.

But is it fair to stick individual homeowners with the costs of insuring against increasingly erratic weather? This is the question insurers and regulators are currently trying to solve. 

A changing climate poses a technical conundrum for insurance companies, whose business model relies on their ability to quantify the risk of an event happening and bear the cost should it actually occur. This means collecting enough money in premiums to cover the cost of claims. It won’t be as simple as raising premiums to reflect the new risk. 

“We are in a world where risk is just increasing day over day because more carbon is going into the system,” Dickon Pinner, a senior partner at the global consulting firm McKinsey, said in the firm’s podcast Reimagine Insurance. “So just transferring that risk is insufficient.”

Unclear outlook for premiums

The growing unpredictability of extreme weather events makes it more difficult for insurers to assess risk. And historical precedents are no longer the reliable indicators they once were.

“The changing nature of climate risk means that the likelihood of these events actually repeating in central Europe over the next 50 years will increase sevenfold,” Antonio Grimaldi, another McKinsey partner, said in the podcast, speaking about the severe droughts seen recently in Europe.

What these changes mean for insurance premiums in the short and long term is unclear. A higher likelihood of devastation could mean insurers raising prices to reflect the increased risk. But prices going too high could discourage people from getting coverage just when they need it most.

On the other hand, a growing sensitivity to the risks of climate change might push more people to insure their properties against catastrophic weather.

“The more people that take out insurance, the lower will be the cost to cover damages, and the greater the scope for insurance companies to calculate premiums,” said Straub. For this reason, he believes catastrophic weather insurance should be required.

In the wake of the floods, Germany’s left and center-left parties as well as the Federation of German Consumer Organizations (vzbv) have called for catastrophic weather insurance to be made compulsory. They added that it’s the duty of the insurance industry to provide homeowners with affordable policies to protect themselves against extreme weather.

Insurers have a new role to play

With a business model that relies on predictability, insurers also have an incentive to use their special role in society to shepherd the transition away from carbon-based energy sources.

“At a macro scale, this is about massive capital allocation and reallocation,” said Pinner. “Thinking through the price signals that the insurers can send to divert capital that currently is going into risky assets that further promote risky behavior, to burn down that risk, versus just transfer it, is actually critical because the rising tide of risk means that transferring it doesn’t solve the problem.”

In its report, the European Commission has suggested many ways the industry might help restore stability. Insurers’ data and knowledge could be tapped to help develop better building code regulations based on their assessment of an area’s risk. Or insurance policies could include clauses that require damaged buildings to be repaired to a higher standard than before, reducing the risk of future damage. 

But for now, people will have to prepare the best they can for weather that is becoming increasingly harder to predict.

“It is not possible to plan where the next flood or landslide will occur,” said Straub. “Anyone could be affected. The more people pay into the insurance pot, the easier it will be, and the cheaper it will be for everyone in the long run.”

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