Flood funding

Written evidence submitted by the Association of British Insurers

The ABI

The ABI is the voice of insurance, representing the general insurance, investment and long-term savings industry. It was formed in 1985 to represent the whole of the industry and today has over 300 members, accounting for some 90% of premiums in the UK.

Summary

· Flooding is the greatest natural threat the UK faces, and the risk is rising. In recent years this increased risk has been reflected in the number and cost of major ‘flood events’ that property insurers cover.

· Flood risk management is the best way of mitigating flood risk and the ABI always supports investment in flood defences by central Government, local authorities, communities and individuals. The more effectively physical flood risk is managed, the more effectively insurers will be able to help consumers manage the residual financial risks, while still running their businesses in a way acceptable to their shareholders and regulators.

· Insurers understand better than most how traumatic and disruptive flooding is and react quickly to help their customers when flooding occurs as events of recent years have demonstrated. 2012 saw widespread flooding across the UK. We are currently undertaking a data collection on the total costs of flood claims in 2012.

· The current flood insurance market, which operates under the temporary Statement of Principles agreement, does not provide optimal outcomes for consumers and is not sustainable in the long term. The Statement of Principles will therefore expire on 30 th June this year and will not be renewed. In the absence of any proposals from Defra, the ABI has taken the lead on developing a long-term, sustainable framework, to provide widely available and affordable flood insurance through its Flood Re model. As with the SoP the Government has a crucial role to play here.

Flood risk in the UK

Flooding is the biggest natural threat facing the UK and flood risk is increasing, because of climate change, development and the gradual deterioration of flood defence assets. In the 1990s, there were two ‘flood events’ with a claim cost of over £150 million for insurers. In the first decade of this century, there were five such events, including the 2007 floods which cost insurers £3 billion.

According to the Environment Agency, in England and Wales:

· One in six homes is at flood risk.

· Over 2.4 million properties are at risk of flooding from the rivers and the sea. Of these around 500,000 are at ‘significant’ risk. A further 2.8 million properties are at risk of surface water flooding alone.

· Over 5 million people live or work in flood risk areas.

· Infrastructure and essential services are also at risk: 55% of water treatment and pumping plants, 14% of electricity infrastructure and 2,358 schools are in flood risk areas.

Flood defence spending

Before the latest Comprehensive Spending Review, the Environment Agency estimated that an additional £20 million per annum (in real terms) was needed for investment in building and maintaining flood defences each and every year between 2011 and 2035 to keep flood risk at current levels (an 80% increase in funding). Pressure on public finances resulted in a cut in flood defence spending in the Comprehensive Spending Review and, as a result, the projected Government funding for the period between 2011 and 2015 is around £800 million behind the trajectory set out by the EA to combat the effects of climate change.

Since then, the Government announced that an extra £120m would be spent on flood defence investment, to be spent mostly on bringing projects forward in the EA’s plans or on projects that can stimulate growth. The ABI welcomes this additional funding, but it only partly addresses the shortfall in funding for this spending review period. In addition, we are particularly concerned that maintenance budgets are budgeted to fall at a greater rate than the overall revenue budget over the same period. This will inevitably mean that maintenance work is able to take place on fewer defence systems, with progressively higher risk defence systems unable to attract funding, resulting in a significant risk that more areas will be at a greater risk of flooding due to the condition of the defences.

The ABI supported, in principle, the Government’s proposals to introduce a ‘partnership funding’ model for flood defence funding when the framework was consulted on in early 2011, but had some concerns about its implementation. Most importantly, we said that ‘partnership funding’ needs to be a complement to robust Government capital and maintenance budgets, not a supplement for them. We now need to see evidence, over multiple years, of ‘partnership funding’ working effectively, supported by appropriate capital and maintenance settlements in the 2013 spending review.

Development

Effective flood risk management requires a rigorous planning system that prevents unwise developments in high flood risk areas. The ABI has taken a great interest in the Government’s recent reform of the planning system towards the more localised model set out in the National Planning Policy Framework. While we appreciate the aims of this transition, and broadly support the policy in the NPPF as it currently stands, we were initially concerned that the safeguards needed to prevent unwise development were not included. While we are pleased that these have been reinstated we remain concerned that effective implementation of the NPPF at a local level may be a challenge. With flood risk already high, and rising, it would be unthinkable to have a planning system that made the situation more severe. To help Local Planning Authorities understand the insurance risks of making bad planning decisions in flood risk areas, the ABI, in collaboration with the National Flood Forum, published ‘Guidance on Insurance and Planning in Flood Risk Areas for Local Planning Authorities in England’ in 2012.

To avoid incentivising inappropriate development, the current Statement of Principles does not apply to properties built after 1st January 2009. This policy position is also likely to apply to any new model such as Flood Re.

Responding to flooding

Insurers understand better than most how traumatic and disruptive flooding is and react quickly to help those who experience it; taking steps to deal with claims and ensure customers recover as quickly as possible. They are highly experienced in responding to similar events and will have acted to increase their capacity for handing claims and giving advice. The 2007 floods in the UK, which cost £3 billion and created a surge of over 185,000 insurance claims, taught the industry valuable lessons about handling big events. Subsequently, all insurers took steps to improve their internal practices. The insurance industry always seeks to improve its levels of customer service and will continue to do so. However, more recent flooding shows that improvements have been effective.

We are currently undertaking a data collection on the total costs of flood claims in 2012. Insurance companies responded quickly to the flooding.

In the event of flooding insurers can provide or pay for the cost of appropriate alternative accommodation and other related additional expenses, such as the removal and storage of undamaged property. They will dry, clean, repair and restore homes, business and possessions or replace them if that is not possible. It may take up to one year or more for homes to be restored and become habitable again because of the time it takes for properties to dry out after being flooded. As a guide, after the floods of summer 2007, around half of those people that had to leave their homes were back in them within six months, almost three quarters within nine months and the vast majority were home after 12 months.

Flood damage is typically expensive. Average domestic flood damage claims typically range from £20,000 - £40,000. This is far higher than the average cost of claims for storm, theft etc which are other key risks covered by domestic property insurance policies.

Flood insurance

The Statement of Principles

Flood insurance in the UK is currently provided under the Statement of Principles (SoP) which expires in June 2013. This was a temporary agreement reached in 2000 between the insurance industry and the UK Government and the Devolved Governments that set out the insurance industry’s commitment to providing flood insurance as a standard feature of home insurance for properties at some risk of flooding, and to continue to offer flood insurance to properties at a significant flood risk. The Government, in return, promised to build flood defences in those areas at significant risk within five years, and made a number of other commitments on the provision of flood data, the planning system, and flood risk management more broadly. It has been renewed on several occasions, most recently 2008. The SoP ensured that unlike in most other countries, private flood insurance in the UK remained widely available as a standard feature of domestic property insurance, although it did not guarantee affordability.

The SoP was only ever meant to be a temporary ’sticking plaster’. It is not appropriate for the long-term, for the following key reasons:

· Customers typically tend to have no choice of insurer;

· Affordability is not safeguarded;

· New entrants to the home insurance market start from a position where they have no commitments under the agreement. This gives them a significant commercial advantage.

As a result, the UK Government, the Opposition, the insurance industry and consumer groups all agree the Statement of Principles needs to be replaced with a more sustainable, long-term framework.

Flood Insurance in other countries

Summary

Flood Insurance in the UK is provided through the private market, as a standard component of buildings and contents insurance policies. A number of other countries take ‘private market’ approaches to flood insurance (Australia, Germany, Austria), though none manage the same levels of coverage for those at high risk as we see in the UK. In other countries the State plays a greater role, ranging from intervention in the market through the backing of flood insurance schemes (USA (partly), France, Spain), to taking full responsibility for flood damage in the absence of any flood insurance market (Netherlands, Denmark).

More detail on key countries is below.

Germany

Insurance covering natural catastrophes, including flooding, is offered as an add-on to household insurance, and administered by private sector companies. Penetration rate is low – less than 10% in 2002. The State does not guarantee to compensate for losses, but the reality is that it has done so on a number of occasions in recent years. It is argued that the assumption that the State will compensate losses has dissuaded a lot of people from seeking flood insurance or taking action to protect their property.

Premiums are based on a system of risk zoning (called ZÜRS), containing four risk bands. Properties in the >1 in 10 year band are generally regarded to be uninsurable and cannot access flood insurance. Excesses are widely used, and commonly range from €500 to €5000.

USA

A pool for high-risk cases has been run by the National Flood Insurance Program (NFIP) since 1968; the rest of the market is served by private insurance. The NFIP provides subsidised insurance to properties in defined zones called Special Flood Hazard Areas. A community must volunteer to become an SFHA, and must demonstrate that the risk is at least 1 in 100 years. An individual cannot access the NFIP without their community being a participant in the programme.

Because cover through the NFIP is subsidised, and because there has been little actuarial input into pricing beyond a vague appreciation of the risk being greater than 1 in 100 years for an entire community, the programme was pushed into a huge debt of around $17 Billion when Hurricane Katrina struck in 2005.

The NFIP has some limited similarities with the Flood Re model (see below), in particular that it provides a subsidy to properties deemed to be at high risk, while leaving those at lower risk to the private market. The key difference is that the NFIP uses an agreed flood risk map to define the high risk areas that can receive a subsidy from the pool, whereas the Flood Re model allows private insurers to make a competitive judgement about whether to cede a risk to the pool.

The NFIP is also funded in a very different way from the Flood Re model. In particular there is no levy on low-risk properties to add to the pool to allow reserves to build up.

France

In France there is a Government-backed but private sector-operated reinsurance pool (the ‘Caisse Centrale de Reassurance’) that operates on an excess of loss basis, indemnifying losses whenever a natural disaster has been declared by Ministers. This applies to all natural disasters; not just floods.

The pool is funded by a levy on all property and motor insurance policies. The surcharge is not related to the risk of the individual property, but is set at a flat rate of 12%. There is a standard excess of €380 applied to all domestic property claims under the scheme. The key aspect of the French (and the Spanish) model is that it takes flood completely out of the private market. There is little appetite for this in the UK.

The Netherlands

Flood risk, from both rivers and the sea, is normally excluded from property insurance policies in the Netherlands. This has been the case since the 1950s, when the Dutch insurance market decided that the flood peril could not be taken on technically, due to the high potential loss. In the absence of any private flood insurance market, the 1998 Calamities Compensation Act provides that, under certain circumstances, the Dutch State will pay compensation to those suffering losses that the market does not insure. This has a maximum annual commitment of €450m. In principle, this would not cover a catastrophic loss from coastal flooding such as the 1953 event, but in these circumstances it is expected that the scope of the Act would be widened in a Royal Decree.

Flood Re

Over the last three years, and in the absence of any proposals from Defra, the insurance industry has been considering options for a replacement for the Statement of Principles which would ensure that flood insurance in the UK remained both available and affordable. Having learned from a number of international approaches, we worked with economic consultants Oxera to develop the ‘Flood Re’ model. The industry has since invested a considerable amount of time and money on this solution and it is the only option which is supported by the industry as able to deliver availability and affordability of flood cover in a practical and dynamic way.

The proposed Flood Re scheme is a not-for-profit flood insurance fund. The fund would be a major improvement on the SoP as it would deliver a competitive market where consumers have real choice whilst ensuring homes at risk of flooding are able to buy affordable flood cover. The fund would provide flood insurance for the 1- 2% (~200,000) properties in the UK where accessing flood insurance in an open market would be problematic. The remaining 98% of properties would continue to be covered by the industry as normal.

Flood insurance for those properties in the fund would be provided at a set price that could be varied by council tax band. The rest of the household insurance price for risks such as fire or burglary would be set by the insurer as normal, and the customer experience of buying insurance from an insurance company would be virtually unchanged. If a claim for flood damage was made from a property which was part of the fund, the fund would then reimburse insurers to meet the cost of the claim.

To make sure that the fund had sufficient money in it, insurance companies would make an annual contribution based on their level of premium income in the form of a levy raised from all insurance premiums. This would complement the income to the fund from the flood premiums from the high flood risk properties in the scheme. While the losses could be smoothed through reinsurance, in the event that not enough funds had built up in the first few years to cover a major incident like the 2007 floods, there would be a deficit needing to be met (effectively a need for an overdraft facility). Exceptionally large losses, such as a catastrophic North Sea tidal surge, may exceed this. We are currently discussing the model with the Government, and one of the key aspects of the negotiation is how we can work together to manage the liabilities of the scheme and raise the funds needed by the pool to operate, and well as the assurances insurers need about investment in flood defences to commit to the solution.

An insurance fund of this kind is a sustainable and stable system. It would mean flood insurance remains widely available with the price effectively set at an agreed threshold. It would be a more comprehensive solution to managing the risk of flooding and make sure a competitive property insurance market is available for all consumers with no significant change in the way they buy insurance.

Without a sustainable replacement for the SoP, we estimate that at least 200,000 high flood risk households could have significant difficulty getting affordable flood insurance. This in turn may make it difficult for homeowners to get mortgages or sell their homes. The Council of Mortgage Lenders has said: "Uncertainty about the future cost and availability of insurance may affect the ability to sell or obtain a mortgage on a property, and is unhelpful to lenders and consumers".

No country in the world has a free market for flood insurance which successfully preserves widely available and affordable flood insurance for those at high flood risk without some form of Government involvement. We urgently need Government to agree to work with the industry to deliver Flood Re if we are to meet our shared policy goals and ensure that the UK has a long term and sustainable plan to tackle the risk of flooding and the ability of high risk households to insure their properties.

January 2013