Charity hazard—A real hazard to natural disaster insurance?

TLDR

After the 2002 European floods, governments provided billions in aid, yet many individuals still lack insurance because they expect governmental relief, a phenomenon termed charity hazard. The study analyzes how government financial relief creates institutional imperfections that hinder the development of natural disaster insurance markets. The authors review existing literature, develop a theoretical framework, and highlight empirical gaps concerning charity hazard. The analysis shows that charity hazard impedes proper diffusion and establishment of natural hazard insurance by creating a barrier to market participation.

Abstract

Abstract After the flooding in 2002 European governments provided billions of Euros of financial assistance to their citizens. Although there is no doubt that solidarity and some sort of assistance are reasonable, the question arises why these damages were not sufficiently insured. One explanation why individuals reject to obtain insurance cover against natural hazards is that they anticipate governmental and private aid. This problem became to be known as “charity hazard”. The present paper gives an economic analysis of the institutional arrangements on the market for natural disaster insurances focusing on imperfections caused by governmental financial relief. It provides a theoretical explanation why charity hazard is a problem on the market for natural disaster insurances, in the way that it acts as an obstacle for the proper diffusion and therefore the establishment of natural hazard insurances. This paper provides a review of the scientific discussion on charity hazard, provides a theoretical analysis and points out the existing empirical problems regarding this issue.