Market needs confidence on flooding insurance
Published: 2 May 2012 | Author: Bernard Clarke
We had been planning to write a piece about insurance cover for properties susceptible for flooding for some time. But the wettest April on record gives spurious immediacy to the topic.
The reason for our initial interest in the subject is that action is needed soon from insurers and the government to seek to ensure that householders in areas at high risk of flooding are able to continue to take out affordable insurance. 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.
The issue of availability of insurance has taken on a greater significance since 2000, when heavy rainfall flooded 10,000 properties, leading to costs for the insurance industry of more than £1 billion. Resultant discussions between the Association of British Insurers (ABI), the government and lenders led to agreement on a "statement of principles" for the insurance market, under which the majority of customers living in areas prone to flooding have been able to continue to obtain cover.
The statement of principles was an agreement between the government and insurers that put obligations on both parties: insurers agreed to continue to provide flooding cover to almost all homes, and the government undertook to invest more in improving flood defences.
Since the agreement was made, the statement of principles has provided helpful clarity and greater certainty for lenders and home-owners on the availability of insurance. Under the principles, insurers committed to continue to offer cover to:
- home-owners in areas where the risk of flooding was not higher than once every 75 years; and
- existing policyholders in areas where there were plans to improve defences to this standard within five years.
However, insurers have not guaranteed to provide cover where no improvements in flood defences are planned.
The ABI has long maintained that the statement of principles is only a temporary measure. When the principles were reviewed in 2008, insurers made it clear that they would not be renewed beyond June 2013.
Most households take out insurance policies annually, so uncertainty about the availability and cost of insurance cover after June 2013 may begin to affect households in areas prone to flooding from the early summer of 2012 onwards.
The views of insurers
Addressing the National Flood Forum Conference in March, the ABI’s James Dalton described flooding as the "biggest natural catastrophe risk" in the UK. He also outlined the insurance industry’s views of the problems associated with the current statement of principles which, he said, had never been intended to be anything more than a "temporary sticking plaster to allow successive governments to organise and fund a more appropriate, sophisticated and sustainable long-term solution."
He warned that the "clock was ticking" and that, without a new approach, up to 200,000 home-owners may begin to find it difficult to get affordable flooding cover. He continued:
"Insurers, the government and groups like the national flood forum all want to see a sustainable, affordable, long-term market for flood insurance in the UK. But we are running out of time…it is widely accepted that the current industry agreement with the government…has thwarted choice for consumers and is past its 'best by' date.
"No action is no option. Insurers are determined to do everything possible to ensure that flood insurance remains as widely available to our flood vulnerable communities. But this cannot be achieved without government help."
The ABI has highlighted what it sees as a series of flaws with the existing arrangements. It believes the ongoing commitment of insurance companies to continue to provide cover where there is a higher risk of flooding allows new entrants to the industry to gain a competitive advantage by "cherry picking" properties where the risks are lower.
The current arrangements also create problems for consumers, the ABI argues, because customers in areas with a low risk of flooding are subsidising the premiums of those with a higher risk. Owners of properties where the risk is higher may also find themselves stuck with their existing insurer and unable to enjoy the benefits of what should be a competitive insurance market.
Issues for lenders
The statement of principles was a major step forward, and has provided re-assurance for more than a decade about the availability of insurance cover for most properties in areas prone to flooding. Under the principles, the existing insurer has, in most cases, continued to offer cover for the property, even when it when it has been sold to a new owner. But uncertainty about the availability and cost of flooding insurance after 2013 raises a number of important issues for lenders and borrowers:
- Insurance is a key component in ensuring a functioning housing market in areas where there is a higher risk of flooding. An increase in the number of properties that are uninsurable and therefore cannot be mortgaged may mean that sales of some homes are restricted to cash buyers. However, all potential buyers may be deterred by flooding risk, a lack of insurance cover and/or the cost of premiums, and the possibility of expensive repairs to the property if insurance is unavailable. Borrowers with mortgages on such properties could find they are unable to move or remortgage, and both the lender and the borrower may be at a disadvantage because of the difficulty of selling the property if there is a need to take it into possession.
An increase in the number of homes that cannot be insured may add to the problems of a property market in which there is already a reduced number of transactions, creating further barriers to mobility. (In each of the last four years, the number of transactions in the UK has totalled only around 900,000 – considerably fewer than the longer term average of around 1.5 million annually.) The inability to sell – or remortgage – a property because it cannot be insured may also create mortgage prisoners: customers who have an existing loan but whose circumstances make it difficult to remortgage, even if their terms could be bettered elsewhere.
- Even if it is possible to obtain insurance, new regulatory requirements for assessing the affordability of mortgages for borrowers may create problems for lenders and their customers. The prospect of significantly higher insurance premiums may affect the ability of the borrower to continue to meet future mortgage commitments, and the lender’s assessment of the affordability of the loan. Uncertainty about the extent to which premiums may rise may make affordability difficult to assess.
- Reduced availability of insurance, and higher premium costs, may have implications for the value of properties against which loans are secured. Lenders will want to ensure that they understand clearly their potential exposure to the risk of flooding and the costs this could impose on their businesses.
The CML’s view
We support the broad objectives of insurers and the government to:
- improve understanding of risks by assessing both the probability and consequences of flooding from all possible sources;
- develop short-, medium- and long-term strategic aims for flood prevention, with an assessment of how much funding is needed and commitments on the allocation of sufficient resources;
- the introduction of a planning system that prevents inappropriate development in areas where there is a risk of flooding and ensures newly-built homes are flood resistant or resilient;
- raise awareness among consumers of the risk of flooding, encourage action to mitigate and minimise the scale of potential problems, and provide information on how to obtain flood insurance; and
- promote access to insurance that is affordable to households on lower incomes.
In the absence of a clear direction from the government, it is difficult to ascertain what the flood insurance market will look like, how many households will be affected and to what extent. This week, we have therefore written to the under-secretary of state for the environment, Richard Benyon, emphasising that the continued availability and affordability of insurance is a key factor in ensuring a stable housing market in areas where there is a higher risk of flooding.
Lenders need to analyse their existing stock of loans and how mortgages may be affected by the unavailability or unaffordability of flooding insurance. If borrowers are unable to get cover, they risk breaching the terms and conditions of their mortgage and may find they are unable to refinance. A prospective purchaser of the property may also be unable to obtain finance. Even if insurance is available, high premiums or excesses could compromise the affordability of the mortgage or of repairs to the property.
Without a clear lead from the government, it may be difficult to ensure that flooding insurance is widely available, at a reasonable cost. Uncertainty could begin to affect lenders and borrowers in the coming weeks. We are therefore keen to begin discussions with the minister and insurers to explore what can be achieved. We hope that a dialogue can begin as soon as possible, so that lenders, insurers, consumers and the government can plan and act effectively, and ensure there is a smooth transition to new arrangements for providing adequate insurance to cover flooding.