14 March 2018
Insurers have started to make use of Flood Re, and plan to do so more in the future. However, they are unsure about its long-term impact. The IFoA’s Flood Working Party explores how this reinsurance scheme for flooding has fared in its first 18 months.
Background
Flood Re launched in April 2016, with the short-term aim of making flood insurance more affordable. It also hopes to make this the case in the long-term (more on that later).
The short-term aim is achieved by simply spreading the cost of flood insurance across the whole market, via a levy on all home insurance premiums. Funded by this levy, Flood Re can allow insurers to cede any home policy to it for a fixed premium, based on council tax band. For homes at high risk of flooding, this premium will generally be less than it would have been before Flood Re’s introduction, when insurance was priced on a risk-reflective basis. Therefore when insurers cede those homes’ policies to Flood Re, they pass on savings (relative to other reinsurance and/or the capital cost of retaining the risk) to the policyholder.
During 2017, the IFoA’s Flood Working Party investigated initial responses to Flood Re, by sending insurers a survey. It collected responses from 13 participants, comprising 56% of the UK home insurance market by premium volume. No actuary will be surprised to learn that there was variation in the responses. But, while the market was not unanimous on all matters, the sentiments observed here reflect those of a majority of respondents.
Short-Term Response
There was full consensus when it came to cessions to Flood Re to date. All participants said that they had ceded some of their book to Flood Re, but less than 1% of it, and mainly renewal business. This is broadly consistent with the 127,326 policies (worth £28m of premium) ceded to Flood Re in the year to March 2017. There are 350,000 homes (or around 2% of the country’s households) estimated to be eligible to benefit.
This information suggests that the market has generally opted to phase in Flood Re slowly, rather than use it to facilitate significant new business. Indeed, more than half of surveyed insurers have not expanded their underwriting criteria in light of it. However, part of the reason for this may be merely practical. Very few insurers have changed policy terms and conditions so far to take advantage of Flood Re, and some said that this was due to business being written through brokers – who may issue a common policy wording - or written through panels, where a change to the terms for the whole panel is needed. Still, despite possible constraints on how quickly they have been able to embrace it, insurers tend to agree that Flood Re is working as intended during its current in-force period. They do think that it will reduce loss volatility, particularly for major events, and that it will cover as much as 30% of their flood claims in the long run. They do think that, eventually, it will improve new business appetite. And they generally agree that the government, the insurance industry, and - though less emphatically - consumers are all benefiting.
Despite possible constraints on how quickly they have been able to embrace it, insurers tend to agree that Flood Re is working as intended during its current in-force period.
Long-Term Impact
As noted earlier, Flood Re temporarily makes flood insurance more affordable, by spreading its costs across the whole market. However, this is only intended to continue for up to 25 years after launch. At that point, the plan is to return to “risk-reflective” pricing. At the same time, the hope is that that pricing will be “affordable”.
As insurers were quick to point out, this two-fold aim appears problematic. After all, it was impossible in 2016: we had risk-reflective pricing, and it wasn’t affordable (hence Flood Re!). Therefore, assuming stable standards of affordability, we can have pricing that is both affordable and reflective of the underlying risk only if there are changes to the risk itself.
Of the ways that we might cause flood risk to “change”, the one consistently highlighted by insurers was a move to promote more resilient repairs. This means repairing flood-damaged homes in a way that will reduce the cost of future flood claims. For example, electrics can be raised above the usual floor level, special plasters and renders can be used, flood-proof plastic doors and concrete floors can be favoured, and one-way drainage valves can be added to some rooms.
Unfortunately, resilient repairs are not commonplace. According to our survey, this is for two key reasons: aesthetics and cost. Firstly, while more than half of our participants do offer resilient repairs, the choice is generally down to the customer. Take-up tends to be low in those cases, as resilient repairs are less aesthetically pleasing, and there is no mechanism (e.g. ABI codes, universal standards) to guarantee that those who have them will save money on their insurance. Secondly, several insurers find resilient repairs more costly, and are therefore unlikely to proceed with them when there is no certainty of retaining the customer’s business for long enough to reap the benefits.
Insurers pointed out these problems. They also pointed out that Flood Re does not directly tackle them. Indeed, more broadly, none of the insurers surveyed thought that Flood Re could fully achieve affordable flood insurance on its own. They agreed that the aim is desirable, and that Flood Re might be helpful in getting closer to it. Flood Re in its current form is only a stopgap measure, without the scope or power to ensure deeper change to the underlying risks it covers. It gives us 25 years to get the job done, but won’t do the whole job for us.
Flood Re in its current form is only a stopgap measure, without the scope or power to ensure deeper change to the underlying risks it covers. It gives us 25 years to get the job done, but won’t do the whole job for us.
In defence of Flood Re, it surely wasn’t expected to do everything on its own in the first place. If it provokes more articles like this, then that’s another way in which it is helping. And it could be a useful vehicle for further solutions – for example, Flood Re could be empowered to subsidise resilient repairs after claims. But the surveyed insurers were almost unanimous that more is needed from somewhere else as well, and almost certainly from government and local authorities, in the form of more investment and incentives. Exactly what that would need to look like is not yet clear – and will therefore be a focus of the working party over the coming year.
