To an increasing extent many EU Member States are victim of a variety of natural disasters, including heavy rainfall, flooding, earthquakes, volcano eruptions and tsunamis. During the period 1970-2007 there has been a substantial increase in the losses due to natural catastrophes. Even recently Italy was hit again by an earthquake causing substantial losses. A major problem is that after every new natural disaster politicians often have the tendency to play Santa Claus and provide substantial amounts of compensation to victims. Those ex post payments are problematic from various perspectives: 1. Since victims will be counting on ex post compensation by the government those payments will reduce the incentives of victims to invest in ex ante prevention, for example by not-building in flood prown areas or by avoiding to put valuables in the basement. 2. Ex post government compensation will also negatively affect the incentives to purchase insurance: solidarity kills market insurance. As a result of generous ex post compensation potential victims will not be willing to buy insurance cover for natural disasters. Why should victims pay premiums for insurance cover if they can freeride on the state?

Given those negative consequences of ex post compensation the preferred instrument would be a first party insurance scheme, i.e. a scheme whereby potential victims themselves purchase insurance cover. The advantage of such an insurance scheme is that the insurer will reward prudent risk-takers and in that way promote disaster risk mitigation. One way of promoting such a scheme is by introducing comprehensive disaster insurance as has for example been done in France, Belgium and Taiwan. In those countries the government moreover provides additional cover by acting as reinsurer of last resort. By providing additional cover as reinsurer the government promotes the functioning of disaster insurance market, thus providing incentives for disaster risk reduction.

The lesson is relatively clear: governments should no longer play Santa Claus or Father Christmas and distribute large amounts of tax payer’s money to compensate disaster victims. Those payments do not adequately incentivize prevention. The better solution would be to mandate the purchase of disaster insurance. Although compulsory disaster insurance would be the preferred solution unfortunately one can, as often, notice that in many countries politicians resist the introduction of efficient solutions for the simple reason that they can obtain political rewards from inefficient ones. In this case the inefficient solution is the ex post Santa Claus payment. After a disaster has struck politicians use ex post compensation as an electoral mechanism, i.e. to gain votes to guarantee free election. That is also the reason why politicians systematically underinvest in prevention of disasters (as prevention can only provide rewards on a longer term) and overinvest in ex post compensation. That is for example the reason why a recent attempt to introduce mandatory disaster insurance in Germany failed: politicians did not want to give their political instrument of ex post Santa Claus payments out of their hands.

 Read more in: Dari-Mattiacci, G. & M.G. Faure, “The Economics of Disaster Relief”, Law & Policy, 2015, Vol. 37(3), 180-208 onlinelibrary.wiley.com and Faure, M.G., “In the Aftermath of the Disaster: Liability and Compensation Mechanisms as Tools to Reduce Disaster Risks”, Stanford Journal of International Law, 2016, Vol. 52(1), 95-178.