Compulsory Insurance against Natural Disasters Only with the Right Premiums

Introducing compulsory insurance against damage from natural disasters makes sense, provided the premiums are set according to local risk factors in Germany. This is the position taken by ifo President Clemens Fuest and the Director of the ifo Institute’s Dresden Branch, Marcel Thum, in a new ifo Viewpoint. “This would allow compulsory insurance to help reduce overall economic damage over the long term. Such insurance creates an incentive to build new buildings in lower-risk areas,” write the two ifo economists. Property owners in higher-risk areas would have to pay more than those in relatively safe areas.

However, Fuest and Thum also warn, “If the fundamentally good idea of compulsory insurance is diluted in the political process – and the current debate already indicates this – such compulsory insurance would do more harm than good.” This would be the case if policymakers decide on uniform premiums. “If damage is compensated for without charging insurance premiums that are commensurate with the risks, there is no incentive to avoid particularly vulnerable areas. As a result, too many buildings will tend to be constructed in vulnerable locations. The costs of this excessive risk assumption will then be borne – at least in part – by the general public via state aid.”