Moral Hazard in Natural Disaster Insurance Markets: Empirical evidence from Germany and the United States

Moral hazard in natural disaster insurance markets has the effect that policyholders prepare less for disasters, which increases the risk they face. However, moral hazard may not arise due to high risk aversion of insured individuals and/or the inherent insurance market context. We offer a comprehensive empirical study of the relation between disaster risk reduction and insurance coverage to assess the presence of moral hazard in two different natural hazard insurance markets. Four econometric models are applied to data from field surveys targeting two different natural hazard insurance markets in Germany and the United States. The results show that moral hazard is in general absent. Nevertheless, evidence for the presence of adverse risk selection is presented because we find that insured households experience higher damage from floods due to a more severe flood hazard. This has significant public policy relevance regarding the existing market structures for natural disaster insurance, such as opportunities for strengthening the link between insurance and risk reduction measures.