Current State of UK Flood Insurance

Holly Deakin contributed to the writing of this blog post

Statement of Principle is expiring on 30 June 2013, there is a one month extension but what’s next?

Background

There are about 29 million homes in England, and 5.2 million of these are at risk of flooding - That’s nearly 20% of all homes in England! There’s no wonder why homeowners of such properties will want to ensure that they have some sort of insurance against flood. In the UK, flood protection is a standard component in home insurance, protecting homeowners for their buildings and/or contents1.

Flooding can occur in many different ways under different conditions and locations. Currently, 2.8 million homes are at risk of surface water flooding, 1.4 million are at risk of river and coastal flooding, and 1 million are at risk of both. So flood insurance is a necessity to many homeowners to safeguard their property and give them ease of mind. By not having flood insurance, a property will be hard to sell and may have an effect on a mortgage as this is secured on the home (the asset) with the expectation that it has home insurance.

For an insurance company, flood risk is difficult to model. Different regions will experience differentiated premiums because the risk on which the premium is written is highly dependent on the geographical location. The profits for insurers are extremely volatile as claims on floods are unpredictable. Hence the capital requirements for insurers are variable and there are no real trends in the past claims data that they can look back on to project with enough certainty.

The pool of risk is steadily changing and the volatile nature of the floods makes flood prevention very challenging. Climate change is having an effect on the risk of flooding. Sea levels are expected to rise, increasing the risk of coastal flooding, and the risk of inland flooding increases due to an increase in the severity and frequency of rainstorms.

The 2007 floods had an estimated insurance claim cost of £3 billion. According to the ABI (Association of British Insurers) a temperature change of 2 degrees Celsius will have a significant impact on the climate and hence have implications to pricing the risk of flood and the claims costs associated with it.

Statement of Principles

There is currently a scheme in place to ensure that homeowners can get flood insurance; known as the Statement of Principles. If without this Statement, flood protection may become more costly as the risk of flood increases and some homeowners may find premiums unaffordable or may be rejected cover altogether. Investment is needed to help protect properties from the risk of flooding, without this investment in flood protection programmes, more and more properties will be at ‘significant’ risk of flooding.

The statement of principles is a set of conditions that are agreed between the insurance industry and the government and put in place to ensure that flood insurance is provided for households and small businesses. This agreement has been in place since 2000 and states that:

1. members of the ABI (association of British insurers) will continue to offer cover (and renewals) for floods and, 
2. the government will manage floods effectively; e.g. they will spend money on flood defence systems

This original agreement expires on 30th June 2013, and will not been renewed. Essentially the insurer will offer affordable renewals to its customers provided that the flood risk is managed adequately by the government. This was initially set up in 2000 and was intended to be a temporary measure, and now alternative solutions are being negotiated to ensure that affordable insurance can be provided for those at high risk.

It is important that some sort of solution is finalised soon. If the issue is left to the free markets, then many people will struggle to get affordable flood insurance as the premiums might be too high. Also if a single large insurer was to stop offering renewals then a lot of people would find it hard to get a new insurer that is willing to offer reasonable premiums. This could price out many homeowners, and would attract negative attention. So the government has an interest in helping to find a solution, and they must work together with the ABI to help develop and create a solution.

Flood Re - Potential Solution?

One of the solutions put forward is ‘Flood Re’, which is a not for profit fund.

• A central pot will offer flood insurance with an agreed set of prices for high risk homes. The premiums they receive will be set aside in the pot and used to pay claims for floods that arise from these policies. The current thinking is the set of prices could vary based on the council tax bands. 
• The industry will set levels of levies which will then be used to top up the fund. For example £5 per policy will be charged on each policy which will be used as a contribution to the fund. The level of levy has yet to be decided. 
• Low risk homes will pay normal ‘flood’ premiums to insurers for their flood premiums.

There are a couple of problems to this solution:

• The Flood Re managers may find it difficult to manage this fund and set the correct prices and arrangements to ensure that it is at a sufficient level. Especially as we know it is difficult to price flood insurance premiums as it is.
• If the fund is exhausted, then the government may have pressure to top up the fund further. This could have further implications as the many people would not want their tax money going on flood defences, especially if they don’t live in a high risk area for flooding
• Those that are at low risk of flooding may be annoyed that they have to pay a levy to top up the fund when they don’t receive any benefit from it. Perhaps the levy will have to be a hidden payment so that most policyholders don’t know that they’re actually paying it. However if the media get hold of this sort of information they may create negative backlash! 
• It will be difficult to ensure that flood risk is managed properly and that the government is continuing its investment in flood prevention whilst also monitoring the impact of climate change

What’s next?

With the statement of principles expiring soon, many homeowners at high risk to flooding might start getting worried if they cannot afford premiums in the foreseeable future or even get rejected cover. They’ll just have to wait to see what the final solution is and hope it arrives sooner rather than later.

The important question here is how quickly the government and insurance companies can reach an agreement. The statement of principles has been extended by a month and now expires on 31 July; this will allow for the on-going negotiations to come to a conclusion. The proposal put forward needs to meet the objectives of the government and the insurance industry whilst also providing cover for those at high risk of flooding effectively. Negotiations are now at an advanced stage, so hopefully we should hear of a solution to this problem in the very near future!

1. The building insurance element will protect them against any damage caused from flooding, cover the costs for any professional fees, and some policies may cover the cost of alternative accommodation. The contents insurance element will cover the cost of repair or replacement for damaged furniture and other belongings in the house.

Source: ABI’s “The Future of Flood Insurance in the UK” presentation at Current Issues in General Insurance 2013