Reducing Flood Insurance Costs by Employing Geographic Risk Complementarity

Abstract

Flood insurance is an important financial measure for flood risk management. However, a significant protection gap in flood insurance exists in many countries due to high flood insurance costs. Reducing flood insurance costs for both policyholders and insurance companies is crucial for implementing flood insurance. This study introduces the concept of geographic complementarity of flood risk to reduce overall insurance costs and allocate individual premiums via the portfolio theory and the cooperative game theory. Furthermore, we introduce expected utility theory to verify the effectiveness of reduced costs on individual willingness to pay (WTP) for flood insurance. The proposed approach is illustrated in China. The results show that there are low correlation coefficients of flood losses across different regions in China, indicating high geographic risk complementarity. Compared with independent insurance in each province, national flood insurance can reduce total premiums by 15.5% and total risk reserves by 62.7%, as well as increasing WTP rates from 12.4% to 23.6%. The provinces of the Coastland River Basin show the greatest decrease in premiums when pooling regional or national flood risk, compared with purchasing insurance by provinces separately. In summary, geographic complementarity in flood risk has significant effects on flood insurance costs and WTP rates, implying that China has great potential to employ this characteristic to implement a national or cross-provincial flood insurance program. Furthermore, the proposed comprehensive approach can also offer new insights for enhancing catastrophe insurance affordability in more countries.