A new flood insurance system in the UK has been proposed by government and private industry, called Flood Re. Swenja Surminski and Florence Crick argue that the new scheme does not provide a convincing answer to how we are going to deal with rising risks due to climate change and the development of floodplains. Private flood insurance will only have a future if it is directly linked to a comprehensive risk management programme that responds to changes in risk over time. These challenges are not unique to the flood insurance debate – in fact they are characteristic of efforts to improve our overall resilience and to adapt to climate change.
During summer 2013, after two years of negotiations, the UK government and the private insurance industry have reached an agreement on how to reform the existing flood insurance system in the UK. The result, a new scheme called Flood Re, has been put out for consultation.
The good news first: Both government and the private insurance industry seem keen to ensure that the UK continues to enjoy the benefits of private flood insurance. We live in one of a very few countries in the world that has a purely private flood insurance market and high penetration rates. This keeps flood losses off the public balance sheet while offering the benefits of a competitive market. But what has been presented by government as the start of a new era of flood insurance may actually be short lived: the proposed reform of flood insurance does not reflect on changing risk levels and it does not provide a convincing answer to how we are going to deal with rising risks.
Ignoring future risk trends?
The risk of flooding is expected to increase due to climate change and development of floodplains for residential and commercial property, as we continue to put more people and assets in harm’s way. With climate change, UK projections published by the government in January 2012 suggest that the number of residential properties at significant risk of coastal and river flooding could range from about 500,000 to 800,000 by the 2020s and rise to between 700,000 to 1.1 million by the 2080s. These figures are likely to be underestimating the total scale of the problem as they do not include surface water risks, which is also expected to increase due to climate change.
With this in mind the design and operation of an insurance scheme should have good risk management behaviour as a core principle, not just by the insured, but also by the government and local communities. It needs to establish mechanisms to foster risk reduction. Private flood insurance will only have a future if it is directly linked to a comprehensive risk management programme that responds to changes in risk over time. The proposed Flood Re does not address this. It is also unclear whether Flood Re has taken into account adequately, if at all, how flood risk is being affected by climate change and socio-economic trends.
Just a few days after the launch of the Flood Re consultation Defra published the Government’s National Adaptation Programme, outlining its strategy on how to deal with climate change impacts over the next years. The plan makes a strong case for flood risk management and points to the risk of insurance becoming unavailable if risks continue to rise. Are these concerns addressed by Flood Re?
It is significant that none of the documents published for the Defra consultation about the future availability and affordability of home insurance in areas of flood risk take into account the impact of climate change on future flood risk. For this reason, Flood Re is likely to be put under increasing pressure and may prove to be unsustainable because the number of properties in future that will be at moderate and high probability of flooding has been significantly underestimated, particularly if one considers the expected increase in surface water flood risk. The Flood Re scheme does not appear to offer integrated mechanisms for flood insurance to play its part in climate change adaptation, and it seems disconnected to the recently launched National Adaptation Programme for the UK.
The case for reform
There is no doubt that reform is necessary. The existing system of flood insurance is under stress: Homeowners and small businesses are concerned about growing insurance costs, while insurers worry about an expanding flood claims burden, and government is keen to keep their own liabilities low in times of tightened public budgets. Finding a suitable solution to address availability, affordability, commercial viability, cost-effectiveness and longevity of a new flood insurance scheme is very challenging and there is no proven best-practice template that could be applied. The debate is not new. We have been here before many times, usually in the wake of a flood. The fact that the private insurance market is still working is partly due to the so called Statement of Principles (SoP) on the Provision of Flood Insurance, which was established in 2000 and reviewed in 2008. This agreement between insurers and government spells out the need for better flood risk information, stricter planning policy and more investment in flood defences as a condition for flood insurance provision. It sets commitments from both the insurance industry and the government to ensure the availability of private flood insurance. While widely praised as an innovative approach to bringing together public flood risk management and private insurance the SoP has some clear limitations: insurers see it as a market distortion, as it only applies to existing insurance policies with an advantage for new market entrants. And those at risk of flooding are getting increasingly worried about rising costs of flood insurance and the prospect of becoming uninsurable if risk levels continue to rise.
The proposed Flood Re offers innovative approaches for dealing with affordability and availability, but falls short of addressing the underlying problem of rising flood risk. The scheme will be run and financed by insurers as a not-for-profit fund which will cover the cost of flood claims from high risk homes. Insurers will pass the flood risk element from those households deemed at high risk of flooding to the fund. Premiums for the flood risk will be calculated based on council tax banding up to a maximum limit depending on the band. Flood Re would charge member firms an annual charge of £180 million. This equates to a levy of £10.50 on annual household premiums and represents the estimated level of cross-subsidy that already exists between lower and higher flood risk premiums.
There is no consideration of how flood insurance and flood risk management will be linked. It is important to remember that flood insurance is only one component amongst the wide array of flood risk management tools and that its effectiveness relies on appropriate prevention and damage control. The existing arrangements governed by the SoP, with all their limitations, did provide links between flood insurance and spending on flood defences, improvements in planning regulations, and access to flood risk information. It is not clear whether the new Memorandum of Understanding between the government and insurance industry will strengthen these links or whether we will lose this link completely resulting in a less progressive strategy towards effective flood risk management.
Government and industry need to rethink how to ensure that flood risk management is taken seriously. For this an increased transparency about flood risk, insurance pricing, claims and public flood policy implementation would help. While commitment to data sharing has been made by government and industry before, with some positive results, there are still information asymmetries, particularly regarding claims data and surface water risks that hamper action.
In addition there needs to be more consideration of the roles that other stakeholders, such as developers and mortgage providers, can play. Flood insurance provides significant benefits for these stakeholders, potentially creating moral hazard, while their role in promoting risk reduction is not formalised.
These concerns have been articulated before and the fact that we are still struggling to find solutions points to a need for step-change. This is an important undertaking: Flooding is the most common and costliest natural disaster facing the UK –claiming lives, disrupting communities and businesses, damaging property and assets and causing stress and ill health. Some of the consequences from flooding can be compensated through flood insurance, but others rely on good flood risk management. These challenges are not unique to the flood insurance debate – in fact they are characteristic of efforts to improve overall resilience and to adapt to climate change. Moving from a short-term fix to a long term holistic solution is what climate adaptation is about. How we address the existing challenges with regards to flood insurance may point the way for overcoming problems in other sectors and areas.
The original article was published under the London School of Economics’ website on September 2013.