4. Managing environmental risk through insurance

Risk is inherent in all human activities, both personal and professional. While the number and variety of risks have grown and changed dramatically throughout history, the basics remain the same: risk of loss of life, limb, health, livelihood, or property due to predictable events (reduced income upon reaching the mandatory retirement age) or to unpredictable events (loss of life in an earthquake). There are some risks that governments, corporations and individuals choose to retain, consenting to pay for any losses that result from those risks. There are many more risks that exposed parties would prefer not to retain. Insurance can often be used as a policy tool to transfer these risks to another party. It has the added advantage that it can encourage the entity through premium reductions to invest in cost-effective risk reduction measures. Increasingly, policy-makers have been exploring the proactive use of insurance as a tool to manage environmental risk effectively. In particular, five attributes of insurance exist that make it an effective risk management tool: its ability to spread risk; its role in variance reduction; its ability to segregate risk; its encouragement of loss reduction measures; and its ability to monitor and control behavior. The precondition for utilizing insurance as a policy tool is that the risk in question must meet a set of preconditions that make it insurable. This chapter explores the role that insurance can play in managing environmental risk. We define environmental risk rather broadly to include natural hazards as well as technological risks. Section 1 explores the nature of environmental risk and the role that the public sector and private insurance can play in managing it. Section 2 then discusses the conditions that make a risk insurable. Section 3 focuses on two examples using insurance to address environmental problems: the role it can play as part of a national strategy for coping with natural hazards and how it can be used in conjunction with third-party inspections to enforce government regulations. The chapter concludes by discussing both the strengths and limitations of insurance as well as suggesting directions for future research.