Adaptation and Adverse Selection in Markets for Natural Disaster Insurance

Abstract

This paper quantifies frictions in uptake, tests for adverse selection, and analyzes welfare effects of proposed reforms in natural disaster insurance markets. I find that willingness to pay is remarkably low. In high-risk flood zones, fewer than 60 percent of homeowners purchase flood insurance even though premiums are only two-thirds of own costs. Estimating flood insurance demand and cost elasticities using house-level variation in premiums from recent US congressional reforms reveals that these homeowners select into insurance based on observable differences in adaptation but not private information about risk. These findings change the sign of predicted welfare effects of proposed policies. (JEL D82, G22, Q54)