The Effects of Geographic Risk Complementarity on Reducing Flood Insurance Costs

Flood insurance is an important non-structural measure for flood risk management. However, a significant protection gap in flood insurance exists in many countries and the high cost of flood insurance is a primary reason. Reducing the flood insurance costs for both policyholders and insurance companies is crucial for the effective implementation of flood insurance. Here, we use portfolio theory to derive fundamental principles of reducing overall insurance cost including premiums and risk reserves through geographic risk complementarity. Furthermore, we propose a reasonable premiums distribution approach among different risk agents to analyze the effect of geographic risk complementarity on individual cost, based on the cooperative game theory. We applied our method in China, which has a large territory but lacks a national flood insurance program. We show there is a low correlation of flood losses across most provinces in China. Compared to the separate insurance in each province, national flood insurance can reduce total premiums by 14.5% and total risk reserves by 61.0%. The regions with highest proportion of premium reduction are the middle and lower Yellow River reaches, which have a lower flood risk correlation with the portfolios of other regions. In conclusion, the geographic complementarity in flood risk has a significant effect on reducing flood insurance cost and the degree of cost reduction depends on the flood risk correlation among different entities. We recommend that China should utilize the geographic risk complementarity to implement a national-level flood insurance program. The method proposed can also provide references for catastrophe insurances around the world.