Flood funding

Flood insurance

Evidence by the Council of Mortgage Lenders

Introduction

1. The Committee is currently considering the issue of flood insurance, and government-ABI progress towards providing insurance to properties at flood risk once the current Statement of Principles expires at the end of June this year. Although the committee has not issued a formal call for evidence, we understand that oral evidence sessions will soon be held to look at this issue in more detail.

2. Ahead of those sessions, we are providing this submission to set out the mortgage lenders’ perspective of the possible effects of a failure by government and the insurance industry to reach agreement on the successor arrangements to the Statement of Principles.

3. The CML is the representative trade body for the UK residential mortgage lending industry. Its 108 members currently hold around 95% of the assets of the UK mortgage market. In addition to lending for home ownership, the CML’s members also offer buy-to-let mortgages to support a private rental market.

The issues

4. Having buildings insurance covering normal insured perils (including flood) is a requirement of all mortgages. This is to protect both the borrower and the lender in the event that an insured event happens to a mortgaged property. If insurance is completely unavailable for a property then a consumer would not be able to buy that property with a mortgage. There would be implications for mortgageability if insurance is available but it is either expensive or has a large excess. This paper sets out some of those considerations in respect of:

• The extent of the problem: how many homes with mortgages are affected

• The existing protections for lenders – Terms & Conditions; contingency insurance

• What lenders might do, faced with uninsured borrowers, or more costly insurance

• Wider mortgage market impacts, and possible regulatory implications

The extent of the problem

5. In estimating the possible number of mortgaged properties which could be at high risk of flooding (and therefore likely to have difficulty obtaining affordable insurance), we have regard to publicly available figures from various sources:

6. The Department for Environment, Food and Rural Affairs estimates (2010 figures):

• 2.7 million properties are at risk from flooding from rivers and the sea

• Around 550,000 properties are at significant risk

• A further 2.8 million properties at risk of surface water flooding alone

7. The Association of British Insurers estimates that 200,000 policyholders have properties which face difficulty obtaining insurance, either because the cost is too high, or because of uninsurable risk.

8. Figures previously provided by HM Treasury suggest up to 50,000 households might experience significant or very significant difficulty in affording insurance.

9. If we assume that the distribution of flood risk for mortgaged properties mirrors that for the housing stock as a whole, then we can deduce how many mortgaged properties may be at risk. To do this, we combine the latest CLG estimate of 27.4 million UK dwellings with CML estimates (Table AP7) indicating 10.0 million owner-occupied mortgages and 1.4 million buy to let mortgages.

10. The respective grossing factors are:

• 36.5% - (10.0/27.4)x100% for properties with a residential mortgage, and

• 41.6% - ((10.0+1.4)/27.4)x100% for properties with a buy to let mortgage.

11. Applying these grossing factors gives:

• On DEFRA figures for properties at significant risk (rivers and coastal): around 201,000 properties with a residential mortgage (36.5% x 550,000), 229,000 if buy to let cases are also included

• On ABI figures: 73,000 properties with a residential mortgage at high risk of being unable to obtain affordable insurance (36.5% x 200,000), 83,000 if buy to let cases are also included

• On HMT figures: 18,000 properties with a residential mortgage, 21,000 including buy to let cases

12. This should be set against the total number of mortgaged properties of around 11.5 million.

13. This may understate the problem as residential properties that are currently owned outright may over time be sold on the open market, when prospective buyers may require a mortgage. We must emphasise that we have extrapolated these figures from the available evidence and that, whilst we are happy with the methodology, we cannot vouch for their accuracy. DEFRA is expected to provide updated figures in January 2013 although to date these have not been released. Our estimate does not consider the number of properties at risk of surface water flooding.

Existing lender protections; would lenders know a borrower is uninsured? what would lenders do?

14. There are a number of safeguards already in place to protect lenders’ and borrowers’ interests. When a mortgage is taken out, the solicitor will check and confirm to the lender that the required insurance is in place.

15. Once the mortgage is in place, lenders are protected by their mortgage terms and conditions (Ts & Cs). These will vary, but typically they will require borrowers:

• to insure the property (including for flood) at all times;

• to keep the insurance in force;

• to provide lenders with details of the insurance if they ask, and prove it is still in force.

16. Some conditions allow the lender to arrange insurance if the borrower does not. Borrowers are usually obliged to inform lenders:

• if the property is damaged, and a claim needs to be made;

• if the insurance becomes invalid or ends and the borrower does not take out a suitable replacement.

17. It is not unusual for Ts & Cs to give lenders the ability to require the mortgage debt to be repaid immediately if the obligation to insure is breached. Immediate repayment might also be triggered if borrowers are found to have given false or misleading information. However, in practice we believe this is a right that would only be exercised in extreme or exceptional cases.

18. Provided that the borrower continues to pay their mortgage, a lender might not be aware that a particular borrower does not have insurance. Lenders do not routinely ask for proof of ongoing insurance, not least because of the current widespread availability of affordable buildings insurance. Customers also switch insurance providers more often as a result of increased competition in the marketplace. Further, an earlier agreement about notification of insurance changes between ABI and BBA has lapsed and not been renewed, mainly because of the frequency of insurance switches.

19. The cost of more frequent or routine checks because of concerns about potential non-renewal of insurance would be disproportionate, given the relatively small numbers of properties estimated to be affected.

20. If a property is flooded and the borrower pays for the repairs themselves, the lender would not know if there was not mortgage insurance in place. If, however, flood damage has occurred and the borrower struggles financially to repair the damage themselves and/ or to afford flood mitigation measures or changes to make their property more resilient in the face of future flood, then the lender might become aware that there is no insurance – for example, if the borrower falls into mortgage arrears.

21. In terms of what lenders might do if a mortgaged property is flooded and insurance is not in place, we expect lenders would take a practical and pragmatic approach, and seek to work with and support their customers. We envisage this would be an extension of the good work and practices of many lenders in supporting customers through arrears and forbearance arrangements. We expect lenders would consider requests for financial assistance to make good the property by way of additional mortgage borrowing, or unsecured borrowing, depending on the customer’s individual financial circumstances. It is highly unlikely that lenders would move to strict enforcement of mortgage terms and conditions from the outset. We expect lenders would work with customers who are found not to have insurance to obtain a minimum level of cover as soon as possible.

22. Some lenders have also taken contingency insurance against a range of risks, such as re-possession, and some contingency policies might cover the lender for loss through flood events. Notwithstanding this, all lenders are required under FSA rules to have sufficient cover in place to meet capital adequacy requirements.

Other mortgage-related impacts; regulatory implications

23. We believe there would be other potential mortgage and regulatory implications if affordable insurance is no longer available or less available than now.

24. It is possible that a rise in premiums would have to be taken into account by lenders as part of their routine mortgage affordability calculations under FSA rules and would therefore have an impact on the amount that someone could borrow. A significant rise in the excess that a borrower has to pay might impact the loan-to-value (LTV) a lender was prepared to offer on an affected property.

25. The two key variables of premium and excess will interact to impact mortgage affordability and LTV: high premiums could impact the amount that someone could borrow; high excesses could result in lower LTVs. Together, the effect could be to undermine recent policy initiatives to tackle consumer access to mortgages/affordability and increase lending with a view to stimulating the property market, housebuilding and the wider economy. Taken to extreme, if properties can no longer be insured, there would almost certainly be a knock-on impact on saleability with some properties becoming unsellable other than to cash buyers looking to pay a reduced price.

26. Lenders might also have to hold additional capital against properties at high risk of flooding to mitigate against the possibility that they are uninsured.

25 January 2013