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Keeping flood insurance afloat

The clock is ticking for the government and the insurance industry to agree on a mechanism for funding flooding insurance if thousands of homes are not to be left high and dry without any cover.

There is currently a voluntary an agreement which obliges insurance companies to offer flood cover as part of their standard policies. But the agreement runs out in summer 2013, and the insurance industry, which says the agreement was only ever a short term measure, does not want to renew it.

The Association of British Insurers (ABI), which represents the UK insurance industry, said earlier this year that the Statement of Principles agreement would not be renewed as it “grossly distorts the market”, adding: “People in lower risk flood areas pay more to subsidise those at higher risk; customers in high risk areas are tied to their existing insurer; and those insurers covered by it have ended up with a disproportionate number of high flood risk properties.”

Once the agreement runs out in June next year, if no solution is reached, it will be up to individual insurance companies to decide if they want to continue providing cover for flooding, and the likelihood is that many won’t – or if they do it will be prohibitively expensive. The ABI itself has estimated that up to 200,000 households in high risk areas – deemed as anything up to a one in 75-year flooding probability – could face problems getting flood insurance.

The ABI believes the government should subsidise insurance for those at greatest risk, claiming there is “no other country in the world where flood insurance is available to high risk customers without some form of government involvement”. However, the government is reluctant to use public money to provide a safety net for the insurance industry.

A Defra spokesman told NCE: “Industry-led solutions that allow insurers to compete even for the highest risk homes, without government intervention in the market, would give the best value for taxpayers’ money.”

Speaking at a conference last month environment minister Richard Benyon said: “Wholesale underwriting of the insurance market by government would not be sustainable or represent value for money.”

He added that other countries that have taken this approach are “counting the cost”, claiming a US government-backed insurance scheme is billions of dollars in debt to the taxpayer.

Instead, he said the government’s role should be to “transition new arrangements” in which insurance companies offer terms that more accurately reflect the degree of risk they are taking on. This free market approach has its critics, including University of York politics lecturer Martin O’Neill and University of Manchester professor John O’Neill, who have co-authored a report outlining how the system of flood insurance in the UK could treat vulnerable people more fairly in the future. The report, Social Justice and the Future of Flood Insurance, says the risk reflective, market-based position defended by Benyon, is “unjustifiably unfair and ultimately unsustainable, and threatens to leave many thousands of properties uninsurable, leading to extensive social blight”.

The academics claim there are a number of possible alternative models, including some currently in operation elsewhere in Europe, that would be fairer and more sustainable – most of which involve the state as insurer of last resort (see box). But the UK government believes the state’s role should be to address the cause rather than the symptoms. “Our priority is to prevent flooding in the first place,” said the Defra spokesman, adding that the department is committed to investing £2.17bn in flood defences designed to protect over 145,000 homes by 2015.

Insurance broker Marsh believes it has come up with a solution that will ensure home insurance in flood-prone areas is widely available and fairly priced after the Statement of Principles expires next year. The broker has joined forces with a digital mapping firm to create a model that identifies and calculates the flood risk of every residential property in the UK. This can be used to come up with a price for flood risk insurance, which insurers will transfer into the international reinsurance market.

Taking the flood risk element out of householders’ premiums makes them more attractive to the general insurance market, the firm says, claiming insurers will compete for their business while the global reinsurance market carries the flood risk element. Marsh also claims the solution – dubbed “Project Noah” – will help government decide where to target investment in flood defences.

Defra has promised an announcement on the replacement for the Statement of Principles later this spring. An early resolution is essential, as anyone whose cover expires after June this year could find it difficult to get insurance if the industry has not decided how it will proceed from July 2013 onwards. Indeed, the Local Government Association claims some insurance companies are already either refusing cover or adding thousands of pounds onto premiums and excess policies in advance of the agreement running out.

The ABI says it is more confident about the discussions since tabling a “pooling” model that would see government financial involvement limited to providing an “overdraft facility” if there was not enough money in the pool to pay out in the event of catastrophic floods, like those of 2007.

Flood insurance outside the UK

France Insurance is provided through a partnership between the state and the insurance industry, with a compulsory levy for natural disasters standard in all policies regardless of the level of risk. The state acts as reinsurer and therefore guarantees payments as insurer of last resort.

Netherlands Flooding is typically excluded from insurance policies, so the state is responsible for losses due to floods not covered by private insurance under the Calamities Compensation Act (1998)

Germany Major flooding is principally covered by public compensation packages. Private risk differentiated insurance is available but there is very low take-up.

US Standard homeowners’ insurance doesn’t cover flooding in high risk areas, but it is covered by the federal National Flood Insurance Program, which offers insurance to communities that agree to enforce sound floodplain management standards.

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