Published by Cherry Chan on
Holly Deakin contributed to the writing of this blog post
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.
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:
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.
One of the solutions put forward is ‘Flood Re’, which is a not for profit fund.
There are a couple of problems to this solution:
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!
Source: ABI’s “The Future of Flood Insurance in the UK” presentation at Current Issues in General Insurance 2013