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After the flood: finding ways to insure the uninsurable without breaking the bank

More wet and windy weather arrives week after week, with the inundated areas of the south and southwest of Britain still at the mercy of the elements. Even while politicians begin the blame game, we should…

How to insure the uninsurable? Matt Alexander/PA

More wet and windy weather arrives week after week, with the inundated areas of the south and southwest of Britain still at the mercy of the elements. Even while politicians begin the blame game, we should look further ahead to when the floodwaters recede, the clean-up begins – and talk turns to who will pay.

In most countries, the government plays a role in covering flood losses. The UK is unusual because the government does not award compensation directly to individuals. Money is provided to local authorities through the Bellwin Scheme to reimburse the costs of emergency measures taken to safeguard life or property. But this is only intended to cover uninsurable risk.

Damage to private property is considered insurable and is not covered, which means compensation is drawn from the insurance industry, or charitable aid. The Prince’s Countryside Fund and the Duke of Westminster were among the first to make donations to help the flood victims, donating £50,000 each. As the floods continue, other businesses have pledged support. The government has also announced new measures, including a £5,000 grant to households and businesses to pay for repairs which improve a property’s ability to withstand future flooding. But most of those with property underwater will have to rely on insurance.

Unchartered waters

Big changes have swept through Britain’s flood insurance landscape. Until last July, flood insurance cover was available to households and small businesses as a standard feature of buildings and contents insurance under the Statement of Principles. Under this agreement, members of the Association of British Insurers (ABI) agreed to cover properties at risk of flooding in return for government commitment to manage flood risk.

Following extensive negotiations a new flood insurance scheme, Flood Re, was announced last June. This establishes a stand-alone, industry-run, not-for-profit insurance fund due to begin in 2015. Flood Re will provide cover for about 500,000 properties deemed at risk by the Environment Agency that might otherwise be uninsurable, or whose premiums are unaffordable. But the limitations of the Flood Re scheme need to be recognised.

While ABI members will continue to meet their commitments to existing customers, there’s no guarantee prices won’t rise between now and the implementation of Flood Re. In fact stories are already emerging about dramatic premium hikes, and the expectation is that these will rise further.

Policy recommendations

The government needs to take responsibility in the event of a catastrophic flood, but Flood Re’s liability will be capped at an expected limit of about £2.5 billion per year, equivalent to a 1:200 year flood loss scenario. As to who will bear the costs beyond this, the government has made no commitment. But this is a question that needs an answer. PricewaterhouseCoopers have estimated the insurance losses for December and January at £630 million, and while it’s too early to count the costs of the current floods, insurance industry forecasts suggest losses could reach £1 billion if the rains continue.

What is also needed from the government and insurers are incentives to reduce flood risk. Planning controls need to restrict development in flood risk areas, set higher standards for buildings on floodplains, and require that the best techniques to improve resilience against flooding are used when rebuilding and refitting after flood damage. As we argued in a paper published in Nature Climate Change, using the flood insurance market to drive better adaptation to flood risk and the effects of climate change needs to be part of a wider strategy that includes land-use planning, building regulations and water management.

The Flood Re scheme needs to be clear whose insurance it will subsidise, and the effects on those not insured under the scheme. In fact many properties at risk will be excluded from the scheme. When Flood Re was first proposed, three categories of property owners were excluded from participation: small businesses, properties built after 1 January 2009, and properties in the highest council tax band.

It has since emerged that Flood Re will exclude many more properties than originally thought, with any policy classed as “non-domestic” unable to participate in the scheme, regardless of the risk. This will include housing association and council properties, many leasehold or private rented sector properties where homes are not insured individually, and properties which are both a residence and a business.

As it is, Flood Re does not reduce flood loss, but only spreads the risk, and therefore the costs, by protecting some policyholders at the expense of others. High-risk properties will be subsidised for decades by payments from low-risk households, with the financial risk still covered by the insurance industry, and government carrying no liability. Policyholders are unlikely to accept this situation without protest, and here the US experience may prove instructive.

Lessons from the US

In the US, flood coverage is excluded from property policies provided by private insurers, and is only available through the National Flood Insurance Program (NFIP), with the federal government acting as insurer of last resort. Following massive payments for flood claims related to Hurricanes Katrina and Sandy, the NFIP is approximately US$26 billion in debt. This led to legislation to reform the program, phasing out subsidies over five years, and increasing the annual rate until premiums reflect the true risk.

But as rates rose and homeowners faced huge bills, sometimes hikes of 600-1000%, they pressured congress to delay these rate hikes. Republicans and Democrats found common cause for once, with the proposal sailing through the normally divided senate in a matter of weeks. Less than two years after the flood insurance reform legislation was passed, the senate voted to delay premium increases for up to four years while the Federal Emergency Management Agency drafts a plan to make flood insurance premiums more affordable and re-evaluates the accuracy of its Flood Insurance Rate Maps.

Flood insurance reform efforts in the US have shown the political implications of angry voters. With flooding in some parts of Britain about to enter a third month and costs spiralling, it is something the UK government is also learning the hard way, with Flood Re facing its first test before it even has come into operation.