The Environment Agency still had 25 “red” flood warnings and 140 “yellow” flood alerts in force across the UK on Monday. This comes as the Association of British Insurers estimated that flood damage this winter will have cost the industry about £1.3 billion. It has been a devastating time for many, and government spending on flood defences has come in for intense scrutiny. Close attention is also needed of the industry’s plan to insure the most at-risk homes.
From April 2016, Flood Re will come into operation. It is a private reinsurer, created with legislative support, which will allow insurance companies to surrender the highest risks. Flood Re will allow affordable insurance for those living in vulnerable areas. In the short term, it will be funded by collecting a levy on insurers operating in the market, estimated at around £10 per house insured per year.
Flood Re will also charge for the reinsurance it sells, but the price is capped by reference to council tax bands. This means that high-risk properties will be subsidised by low-risk properties, but Flood Re is required by law to reduce this level of subsidy over time. This gives the government time to deal with high risk areas while shifting towards charging on the basis of the actual risk of flooding. Home owners will not notice any difference: Flood Re will deal exclusively with the primary insurers. But those setting up Flood Re face some unique challenges.
Risking it all
The reinsurer is charged by law with pursuing two goals: a move towards “risk reflective pricing” for flood insurance; and maintaining available and affordable flood insurance for residential properties.
These goals are conflicting. Current premium levels in the market do not reflect the risk borne, meaning that the flood component of home insurance for high-risk households is subsidised by low-risk households. If premium levels for high-risk households reflected the true risk, they would be unaffordable for some.
Meeting both of the stated goals requires a future where the risk of flooding has been steadily reduced by preventative measures and the price of flood insurance has become naturally low, because the risk has also become low. This could prove a dangerous assumption.
In fact, some might say that the global uncertainty of climate change and the political uncertainty around spending on flood protection make such a future a Utopian ideal but the statute expects it to be made real in less than 25 years.
Flood Re’s conflicting statutory goals raise the question of which goal will have to give way: “risk based pricing” or “affordability”? The Water Act 2014 contains provisions supporting Flood Re but does not indicate the priority. In the short term, those in charge of Flood Re will have to determine which is more important. Since Flood Re and the insurance market it supports cannot ultimately be permitted to become insolvent or dysfunctional, risk-based pricing at a higher level may well become a necessity, pushing insurance premiums upwards.
There are other issues too. Flood Re can provide advocacy and policy advice to government, but its core role is as a reinsurer, and as such it does not have any tools to directly influence homeowner behaviour as an insurer might do, through premiums or rewards for risk averse protection measures.
It can potentially influence the level of “excess” that the insured must bear before the home insurer becomes liable. But it has no regulatory powers and its influence over primary insurance will probably only ever be marginal. It is also limited to homes; it will not cover buy-to-let properties, small businesses or apartment blocks, and it is worth noting too that council tax bands are a comparatively poor indicator of disposable income, given the differences in the bands across the country.
There is also the issue of increasing costs. The initial direct cost borne by each householder is relatively low at £10.50 a year – the premium passed on to Flood Re – but this can be increased. In the event of a costly policy year, Flood Re can call for additional contributions from insurers. Even where necessary, price increases and additional calls for funds may well cause Flood Re to be unjustly perceived as a costly white elephant.
Flood Re can achieve some important goals. In the immediate term, it will be able to absorb the worst risks, allowing insurers to establish realistic market price levels for the vast majority of commercially valid risks. Over time, it will collect UK flood insurance data, which – depending on how it is made available – should help in monitoring the effectiveness of government and private action to control the effects of climate change.
Flood Re’s intended lifespan ending in less than 25 years should hopefully spur significant government action in high-risk areas. It seems doubtful that successive governments over four parliaments will uniformly treat the massive capital investment necessary as a priority, but Flood Re can at least encourage government to invest in flood prevention, mitigation and resilience to allow the phasing out objective to be met.
This new reinsurer is a necessary measure. Market distortions designed to protect homeowners and consumers have caused prices to remain artificially low. The unavailability of flood insurance is not an option for social reasons – misery and social disruption would result if large neighbourhoods became permanently uninhabitable. But the extent of this year’s flooding and the prospect of more to come undermines both the central assumption in the establishment of Flood Re and its ambitious, conflicting targets. No one can guarantee that the climate will play ball, or that politicians will dig deep to honour a previous regime’s commitments.