Governments often step into the insurance market following a natural disaster, setting up state-controlled schemes when insurers are considered to have failed.

It won’t surprise anyone in the insurance industry to hear many of these schemes have the perverse outcome of encouraging risky behaviour, because property-owners don’t have to face the consequences of their actions.

Now a group of researchers from Risk Frontiers at Macquarie University, Aon Benfield Analytics and the University of Colorado have discovered just how damaging government insurance mechanisms can be.

Their research on adaptation to climate change has also found that increasing losses from natural disasters are often blamed on human-influenced climate change when they are more likely due to growing populations in disaster-prone areas, rising wealth and the tardiness of property owners and governments in reducing hazard.

John McAneney of Risk Frontiers, one of the six authors of the report, is adamant tough decisions are needed now.

The researchers have not ruled out the threat of human-influenced climate change, and Professor McAneney says mitigation now will reduce such risks in the future.

That means governments standing firm on inappropriate land development – not an easy position in Australia, where a growing population needs more housing.

He says there is a limited amount insurers can do to prepare for climate change.

With the typical insurance policy running for a year, pricing will not reflect future changes in risk and the best insurers can do is price to reflect current threats, according to the report, Market-Based Mechanisms for Climate Change Adaptation.

Property owners are generally reluctant to mitigate risk, and even those who have experienced a flood or bushfire want to rebuild in the same place, it says.

That finding was expected, Professor McAneney told insuranceNEWS.com.au. Studies here and abroad show people consistently underestimate risk and overestimate their ability to cope with natural disasters.

What does come as a surprise is that the researchers have found they can’t recommend any program involving government insurance mechanisms.

They examined government schemes in the US, Europe and New Zealand, and expected to identify the best schemes or elements that could be used to encourage changes in behaviour.

But they found that government-subsidised insurance premiums encourage development in hazard-prone areas. For example, in the US, where political intervention kept premiums low to encourage people to buy insurance, there was more construction in flood zones.

“None of the schemes examined provide a clear model for Australia, and this country should reflect very carefully before introducing any government pool to deal with natural catastrophe risks,” the report says.

Professor McAneney says when governments step into the market after a disaster, they assume a legacy of “inappropriate land use, unrealistic risk assessment and lack of consideration to mitigation”.

Intervention then obscures risk signals, because those with low risk are forced to subsidise high-risk property owners.

Because insurers have only recently started offering widespread flood cover in Australia, it is too early to know if policies are changing behaviour.

But Professor McAneney says Suncorp’s decision not to write new cover in Roma and Emerald sent a strong message to governments about land use planning and disaster mitigation.

The report says encouraging adaptation to climate change will probably need a high degree of compulsion, and this is not the role of the insurance sector.

“Risk-rated premiums would send a transparent risk signal to all parties and, if this were successful in changing behaviour, over time the population at risk [from] natural disasters should decrease, or at least not continue to rise in concert with increasing general population and wealth.”

But the researchers say they have found few instances of this happening.

In considering how a current risk concentration can obtain affordable insurance from the private sector, they priced a hypothetical flood catastrophe bond for homes and contents in the Hawkesbury River basin of northwest Sydney.

They found a four-year cat bond would cost 15-75% more than traditional reinsurance to cover an area of 22,000 square kilometres from Goulburn almost up to Singleton, in which floods can occur at any time of year.

Although the costs would be high – and there is enough reinsurance capacity in Australia – they say there would likely be high demand for the bond, which would offer investors geographic diversification and a different peril from bonds for European windstorms, earthquakes and US natural disasters.

The researchers say the real issue is that climate change is a complex policy area. “It should be clearly kept in mind that insurance is a mechanism that transfers disaster risk; it does not do away with the risk.”

But risk-informed land development, improved building codes and flood defences can dramatically reduce risk.

“Any gains achieved here will put us in good stead for additional changes that a warming climate may eventually throw at us,” the report says.