7 Household flood insurance
60. Around 2% of households are considered to
be at high risk of flooding; in a free market these properties
would incur higher premiums than if they were located in a low
flood risk areas to reflect the higher risk of claims for flood
damage.[120] Insurance
for such homes, as well as for small businesses, is currently
provided in line with a 'Statement of Principles' agreed between
the Association of British Insurers (ABI) and the Government in
July 2008. Under this, insurers agreed to provide until the end
of June 2013 flood insurance to the vast majority of households
and small businesses in areas of 'significant flood risk' where
plans exist to reduce the risk below 'significant' within five
years. Properties built from 2009 onwards are not covered by the
Statement.
61. The ABI considered that the Statement of
Principles was only ever meant to be a temporary "sticking
plaster," not appropriate for the long term for the key reasons
that customers typically tend to have no choice of insurer, affordability
is not safeguarded, and those new to insuring homes have no legacy
of commitments under the agreement giving them a "a significant
commercial advantage".[121]
We raised with Ministers on numerous occasions the urgent need
to reach agreement, including in our Draft Water Bill report
published in February.[122]
The report cited evidence from the Local Government Association
that, should the insurance industry's agreement to provide cover
to the more than 5 million properties in flood risk areas be withdrawn,
there would be a danger of blight, with significant impacts on
the housing market and social cohesion.
62. Ministers told us that they were working
urgently to find a solution with the insurance industry, but did
not wish to conduct negotiations in public.[123]
We requested that Defra provide details of the legislative solutions
being considered in the Government's response to our Draft
Water Bill report. We regret that, in spite of repeated requests
from us, the Government only published this on 27 June, promising
a further public update at the earliest opportunity.[124]
On the same day, Defra launched a public consultation on how the
Government intended to move forward. Insurers agreed to continue
to meet their commitments under the Statement of Principles until
such time as a new model, Flood Re, could begin operating.[125]
63. We welcome the Government's
increased funding for flood defences which has enabled the insurance
industry to undertake to continue to provide affordable flood
insurance under the Statement of Principles regime until new arrangements
can be put in place. The Government and insurance industry have
had a number of years to consider future arrangements and we regret
the delay in announcing a solution. This uncertainty has exacerbated
the concerns of householders facing potentially significant rises
in insurance premiums. The Government must conclude negotiations
urgently on the details of the measures it proposes so as to spell
out clearly the arrangements which will apply in the future and
end the current uncertainty.
Potential models for flood insurance
provision
64. The focus of evidence to us was on two main
approaches'Flood Re' and 'Noah' (modified to 'Flood Mu').
Much media focus has been on the former; a model proposed by the
ABI. However, representatives of the insurance and reinsurance
industry presented arguments to us on the merits of alternative
models, including the Noah/Flood Mu model, and Flood Re Mutual
proposed by Richfords Fire and Flood, discussed below. Media reports
indicate a high level of disagreement within the sector over the
best way forward. and no model garnered universal support from
witnesses to this inquiry.[126]
Flood Re
65. The ABI told us that, in the absence of any
proposals from Defra, the insurance industry had developed a 'Flood
Re' model with economic consultants Oxera. This approach would
provide a not-for-profit fund to provide flood insurance to the
1-2% (around 200,000) of properties where, according to the ABI,
obtaining insurance on the open market would be "problematic".[127]
The Association told us that under Flood Re policies for these
properties would be charged at a set price, according to council
tax band. It estimated that in a free market premiums for a home
in a high risk area would be around £1,400 as opposed to
around £750 under Flood Re.[128]
Any insurer paying a claim for flood damage to such a property
would be compensated from a fund built up from annual contributions
from insurance companies based on their level of overall premium
income. Companies would fund this contribution from a levy applied
to all their household insurance premiums.[129]
The ABI told us that this household levy would be around £3
per contents policy and £5 per buildings policy per annum.[130]
Under this model, the Government would be required, at least initially,
to be the 'insurer of last resort' in the event of an extreme
flood event that overwhelmed the capacity of the fund to meet
consequent claims. The ABI noted that taxpayer support would be
withdrawn once the fund had accumulated sufficient funds to enable
it to "handle any likely flood on its own".[131]
However, if the Government did not provide such back-stop funding
guarantees, the scheme costs would increase from the current annual
cross-subsidy value of some £150 million to around £280
million.[132] This
would significantly increase the estimated cost per household
per year.[133]
66. Flood reinsurance is a key aspect of the
model. Reinsurance company, Aon Benfield, which has been working
with the ABI on the details of Flood Re, noted that all insurance
companies in the UK buy some form of reinsurance protection for
their property exposures (risks) which provides "a robust,
proven, and well regulated mechanism for transferring risk and
protecting insurers' financial positions".[134]
The company considered that reinsurance had a key role to play
in managing Flood Re's 'survivability' (the ability to meet its
obligations) and 'sustainability' (the ability to survive and
trade after an event). Reinsurance achieved this through substantially
reducing both the probability of failure and the volatility of
results. The company's early estimates were that Flood Re's ability
to pay out for a single catastrophic event would be some £2
billion, "far in excess" of the scheme's estimated premium
income.[135]
67. However, Flood Re has been criticised by
some in the insurance and reinsurance industry. Insurance company
Marsh Ltd suggested that the model would create perverse incentives
for homes in high-risk areas not to manage their flood risk and
for developers to build in such areas, prices would rise excessively
as tariffs would not be contested, and reinsurance costs would
be substantial.[136]
The ABI countered that the scheme would not apply to newly built
homes and that by improving individual property protection a home
could come out of the scheme and find cheaper cover in the 98%
of the market which remained a free market.[137]
Noah/Flood Mu
68. An alternative approach, Project Noah, was
proposed in April 2012 by the insurance companies Marsh and Guy
Carpenter.[138] This
aims to provide a pooled risk approach and is predicated on balancing
out risk across the country since it was considered unlikely that
floods would impact on all areas of the UK at once. Risk would
be ceded in some proportion to the reinsurance industry. The model
would use detailed flood risk maps to assess premiums and risk.
The company described a key advantage of Noah as the fact that
the model would require "no taxation, no subsidy, no levies,
no legislation, and no additional infrastructure". Further,
under Noah, there would be no contingent liability on the Government
for flood losses, the relative merits of proposed flood defences
could be considered, and householders could reduce premiums by
improving their property's resilience to flood.[139]
The ABI has criticised the Noah model, stating that it would not
ensure affordable cover for customers, would require extensive
government support, and was reliant on the international reinsurance
market being able to accommodate it. It further added that control
over price would sit with one organisation in charge of the Noah
pool and that this would lead to the loss of the free market advantages
which would, however, continue to apply under Flood Re.[140]
Noah was therefore not supported by the ABI's members.[141]
69. Marsh Ltd presented a variation on Noah,
'Flood Mu', during its evidence session with us in March. This
proposed a risk-pooling solution, with a pre-set amount of flood
claims in a given period being redistributed across all insurers
in proportion to the size of their business in household cover.
Some risk would stay with the original insurer, the proportion
of which had yet to be determined.[142]
Insurance companies could obtain reinsurance for their retained
risk via the Noah model. The ABI also criticised this variant
of Marsh's model, considering that it would not safeguard affordability
of premiums or the availability of cover, nor would it incentivise
the Government to invest in flood defences.[143]
Flood Re Mutual
70. The Committee received evidence from Richfords
Fire and Flood proposing a variation on the Flood Re model; 'Flood
Re Mutual' under which a levy on all insurers offering household
insurance would be pooled to fund reinsurance and pay out for
areas with a greater than 1-in-75 year flood risk.[144]
It considered the advantage of this approach would be that the
insurer of last resort would be a mutual fund with assets invested
for the benefit of its membersthe UK public not corporate
shareholders. Richfords recommended that legislation be put in
place requiring all insurance companies to impose a levy equivalent
to the value of 0.03% of the rebuilding cost specified in buildings
insurance policies and 0.06% of the sum assured in contents polices".[145]
This appears to produce a higher average cost per household than
Flood Re. The ABI questioned whether a method similar to that
used by Noah, such as the Richfords model, which cedes flood risk
into a mutual pool could guarantee to maintain affordable premiums.[146]
Open market
71. It should be noted that some parts of the
industry consider that an open market in flood insurance could
provide an affordable approach for homeowners. The British Insurance
Brokers Association (BIBA) told us that, for the 2% of high-risk
properties which found it harder to find insurance, the Association's
not-for-profit signposting facility would help "suitable
cover" from a specialist broker.[147]
BIBA stated that its members already found cover for 95% of homes
rejected by insurers for flood cover. Under a free market the
vast majority of property owners would continue to access flood
insurance "in the normal way with insurers providing cover
as part of the standard bundle of perils".[148]
The Association considered that only some 10,000 properties would
present a real problem.[149]
BIBA noted that any of the three approaches (Flood Re, Noah, or
open market) could be developed to provide a "suitable solution"
and recommended that a combination of approaches be discussed.
However, for a market solution to work after the Statement of
Principles expired it would be necessary for there to be signposting
to specialist brokers, more promotion of resilience in properties,
a fuller appreciation of the value of flood defence spending,
and co-operation between owners, insurers, brokers, Defra, the
EA, HM Treasury, reinsurers and local authorities.
Government proposals: Flood Re
72. After we finished taking evidence, on 27
June, the Government launched a six week public consultation on
its proposal to adopt the Flood Re model under which up to 500,000
high risk households could benefit by paying "significantly
less for their insurance than they might otherwise". The
model would also constrain the excesses that could be imposed
on households at high flood risk.[150]
An insurance pool would be established in which premiums paid
by households at low risk subsidised those of households at high
risk of flooding. Ministers noted that as the levy would capture
the existing cross-subsidy it would not impact customers' bills
"in general".[151]
The levy would be set at £180 million per annum which notionally
equates to around £10.50 per customer per year, set for the
first five years.[152]
This is an increase on the £8 figure that the ABI cited in
evidence to us as the likely cost per customer each year. If the
scheme were to have insufficient income to meet outgoings, an
additional amount would be charged to each member company. The
Memorandum of Understanding between the Government and the insurance
industry notes that the flood risk element of premiums paid by
households in Flood Re would not exceed £210 for a council
tax Band A property, rising to a limit of £540 per annum
for a Band G property. However, "genuinely uninsurable"
properties would be excluded from the scheme, as would Band H
properties and those built after 2009. In addition, the Memorandum
commits the Government to long term investment in flood defences
and to taking primary responsibility in the event of an extreme
flood event, with Flood Re and representatives of the insurance
industry, in deciding how any available resources should be distributed
to Flood Re customers as part of "wider Government action
to respond to such a national emergency". The annual liability
collectively to insurers would be capped at the level of claims
payable in a 1 in 200 year loss scenario.[153]
73. Flood Re would only operate for a limited
time; it would be withdrawn within 20-25 years. Whilst stating
that an immediate move to a free market would cause "significant
hardship for many households", the Government wished to see
a "transition to a free market for flood insurance so that
flood risk is accurately reflected in prices and the right incentives
are in place to manage the risk of flooding".[154]
Ministers stated that "in the long term we need to create
a situation where everyone is fully aware of their level of flood
risk, and households and communities are rewarded through their
future bills for the steps they take to reduce flood risk".[155]
However, the consultation does not propose measures to ensure
that developers who have built in areas at high flood risk share
with householders the future costs of premiums which reflect fully
the risk of flooding.
74. The Government acknowledges that Flood Re
does not achieve "the level of value for money normally required
of Government policies" since the costs of Flood Re, including
the necessary reinsurance contract, are expected to be greater
than its economic benefits. A Ministerial Direction would be required
before implementation can proceed.[156]
However, it is not clear how Parliament will scrutinise this Direction,
but it must be subject to Parliamentary scrutiny.
75. Provisions are included in the Water Bill
to enable direct regulation of the insurance market if Flood Re
"does not deliver what we need and insurers are otherwise
unable to keep prices at affordable levels".[157]
The regulatory fall-back option, the 'Flood Insurance Obligation',
would require insurers to cover a set share of high risk properties
or face penalties.[158]
Such a regulatory framework must be open, transparent and subject
to Parliamentary scrutiny.
76. Ministers concede that Flood Re constitutes
a "novel approach," with many details still to be worked
through with the industry, including the relationship between
Flood Re and Parliament. Flood Re, rather than Ministers, would
be directly accountable to Parliament for its operations, with
Ministers remaining accountable for overall flood insurance policy.
The Government proposes introducing a "bespoke scrutiny,
administrative and regulatory arrangement" for Flood Re since
this would avoid the scheme's funding being considered tax and
therefore public expenditure.[159]
However, the Government states that these arrangements "offer
Parliament less control and less insight into Flood Re's operations"
than if the scheme were treated as part of the public sector.
Flood Re would also be likely to be classed as State Aid and would
need European Commission approval.[160]
77. It is clear that no single approach has the
backing of the entire insurance and reinsurance industry. There
are advantages and disadvantages to each approach but the fundamental
choice to be made is whether or not some flood insurance customers
should be subsidised through an increase in premiums paid by all
households. The ABI noted that it was a decision for "us
as a society to make about our willingness for the 98% to effectively
pay something towards the costs of the 2%".[161]
The Government has proposed that ultimately the free market should
provide flood cover in order that risk is accurately reflected
in the premiums charged so as to prompt the right decisions on
the location and resilience of homes to flooding. It has, however,
recognised that to move immediately to such a free market would
cause some people "significant hardship".[162]
The Government estimates that some 500,000 households would benefit
from a subsidy system, while the insurance industry told us that
some 200,000 of the UK's 26 million households could face increases
in premiums without it. However, according to insurance brokers
only 10,000 households posed a significant problem. Nevertheless,
the threat of increased premiums exacerbates the fears of those
living in flood-prone areas about the impact not only on their
ability to pay the annual insurance costs but also on the value
of their homes and the potential blighting of whole communities.
78. The ABI conceded that evidence was "patchy"
on whether or not those living outside high flood risk areas would
be willing to pay a levy to support those living in such areas".
[163] However,
the current Statement of Principles already provides an element
of cross-subsidy, albeit hidden within the insurance system.
79. We were not persuaded that
the open market would be able at present to offer affordable insurance
to all households. We welcome the Government's recognition that,
whilst premiums should in time reflect a property's risk of flooding,
this transition should only take place over a long timescale.
A solution must be found to ensure that insurance is available
for those homes built in areas at high risk of flood which would
be unable to obtain insurance.
80. We endorse in principle
the agreement between the Government and the insurance industry
to introduce a levy-funded insurance pool for households at high
risk of flooding which will keep premiums affordable for all.
Flood Re will make transparent the current implicit cross-subsidy
under the Statement of Principles so that householders are fully
aware of the contribution they are making. This approach will
provide stability for communities and certainty for householders
in future.
81. However, the Government's
announcement raises many questions about the operation of Flood
Re, in particular how the scheme will be accountable to Ministers
and Parliament, and how taxpayers' interests will be protected
in the event of an extreme flood event requiring funding beyond
the capacity of the scheme. It is unclear who will bear the costs
from such a 1 in 200 year flood event.
82. We are also concerned that
the approach does not achieve the value for money normally required
of Government policies. Furthermore, it is not clear how assurances
will be enforced to limit the amount of levy to be paid by all
householders and maintain premiums at affordable levels for those
in the scheme. The regulatory regime must be fully transparent
and open to Parliamentary scrutiny.
83. Ministers concede that they
must publish further details on these issues. These must be provided
urgently so that Parliament can scrutinise fully both the Flood
Re scheme proposals and the measures in the Water Bill.
120 Q 168 Back
121
Ev 71 Back
122
Environment, Food and Rural Affairs Committee, Sixth Report of
Session 2012-13, Draft Water Bill, HC 674 Back
123
Q 374 Back
124
HM Government, Government response to the EFRA Committee's
pre-legislative scrutiny of the draft Water Bill, June 2013,
Cm 8643 Back
125
Defra, Securing the future availability and affordability of
home insurance in areas of flood risk, June 2013 Back
126
For example "Free Market looms for flood insurance",
POST online, 27 March 2013 Back
127
Q 168 Back
128
Ev 72 Back
129
As above Back
130
Q179 Back
131
"Flood insurance talks at critical juncture", ADA Gazette,
Winter 2012 Back
132
Q 222 Back
133
The cost per household premium per year is cited in the Government's
consultation on Flood Re as being £10.50 per year Back
134
Ev 68 Back
135
As above Back
136
Ev 103 Back
137
Ev 75 Back
138
"Ground breaking industry solution to enable fairly priced
flood insurance for all UK households", Marsh Ltd press release,
3 April 2012 Back
139
Marsh Ltd background note to the Committee Back
140
Q 172 Back
141
POST online, 4 April 2012 Back
142
Ev 103 Back
143
Ev 74 Back
144
This represents a 1.3% chance of a flood event occurring in any
one year Back
145
Ev w25 Back
146
Q 216 Back
147
Q 242 Back
148
Ev 85 Back
149
Q 250 Back
150
HC Deb, 27 June 2013, col W468 Back
151
As above Back
152
Defra and Association of British Insurers, Flood Re Proposal:
Memorandum of Understanding between Defra and the Association
of British Insurers, June 2013 Back
153
As above Back
154
Letter from Richard Benyon MP to Anne McIntosh MP, 27 June 2013.
See www.parliament.uk/efracom Back
155
As above Back
156
Defra, Securing the future availability and affordability of
home insurance in areas of flood risk, June 2013 Back
157
See Water Bill Clause 47 and Explanatory Memorandum Back
158
Letter from Richard Benyon MP to Anne McIntosh MP, 27 June 2013 Back
159
Defra, Securing the future availability and affordability of
home insurance in areas of flood risk, June 2013 Back
160
As above Back
161
Q 174 Back
162
Letter from Richard Benyon MP to Anne McIntosh MP, 27 June 2013
Back
163
Q 180 Back
|