Will the cuts be too deep?

The hard bargaining begins today on the future of flood protection funding when government ministers meet insurance industry representatives, local government leaders and environmentalists at a summit in London.

It’s an issue that is particularly pressing for the industry as the agreement with the government on the provision of cover in flood-prone areas – the so-called ‘statement of principles’ – reaches the end of its five-year lifespan in 2013.

The ABI has pledged that its members will continue to make flood insurance available as part of standard household cover, in return for a government commitment to develop a long-term flood protection strategy.

For much of the past decade, annual negotiations over this agreement were a source of friction between the two groups until they agreed in 2008 to a five-year extension.

National Flood Forum chief executive Mary Dhonau says: “The fear is that the insurance industry will leave people high and dry without flood cover. We want flood insurance to be accessible and affordable. It should remain part of core insurance products.”

Today’s event is shadowed by next month’s comprehensive spending review (CSR), which will determine expenditure on flood defence for the next three years.

Defra faces 40% cuts

It is no secret that public money is tight, following the government’s commitment to cut £90bn off annual public expenditure by the end of this parliament.

The squeeze will be felt more acutely in certain areas, with the Department for Environment, Food and Rural Affairs (Defra), facing reductions of up to 40%. Other budgets, such as health and education, will be protected from the full brunt of the cuts.

So far, flooding has escaped from the firing line. In her first statement as environment secretary, Caroline Spelman, who is understood to be on the verge of submitting her departmental bid to the Treasury, pledged that this year’s increased flood investment was safe.

Dhonau says: “With the CSR, everybody is very concerned that there’s going to be a significant cut in flood risk management.”

AXA public affairs head Phil Hickley agrees. “There is concern that flood spending will come under the hammer.”

Flooding minister Richard Benyon has stoked concerns about future investment in flood defences. At a recent conference, he refused to be drawn on whether the forthcoming review would maintain existing spending.

According to a statement issued by Defra to Insurance Times, while the government is committed to making improvements to flood defences, “any further decisions on spending will be subject to the ongoing spending review”.

Even Spelman’s pledge to safeguard existing spending isn’t quite what it looks like. Defra has asked for £30m of what it describes as “efficiency savings” on the flood defence budget.

The problem for the insurance industry is that, while there is a short-term need to balance the books, the long-term need for investment in flood defences grows inexorably.

Rainfall increases 100mm

Average annual rainfall in the UK increased from 850mm in the early 1900s to 950mm by the end of the century, reflecting a warmer, wetter climate. Many scientists say it is a trend that is set to continue.

The ABI has warned that a 2°C increase in average temperatures will cause average flood-related losses to go up £47m, pushing up the price of insurance policies by 16%. A 6°C increase would lead to extra losses of £138m, equating to a 47% increase in premiums.

It says that the 2007 floods in the north and west of England resulted in 165,000 claims costing £3bn – more than three times the usual annual cost of weather-related claims in the UK. It described the 2007 events as “one of the biggest challenges” that the UK industry has encountered.

The Chartered Institute of Loss Adjusters calculates that the cost of settlements in 2007 averaged £30,000 for domestic and about £100,000 for business claims.

The big insurers bore the brunt of these losses. Aviva, in its former incarnation as Norwich Union, estimates that the 2007 events cost it £340m – and this came on top of £200m worth of flood-related losses in 2000. Meanwhile, AXA believes that the 2009 floods that devastated west Cumbria cost it £60m.

Under Labour, annual investment in coastal and river defences rose to this year’s £800m.

As a result of increased levels of investment since 2003/04, the Environment Agency estimates that 400,000 more households are now protected.

Investment ‘should be doubled’

But in a report published last year, it warned that even this increased spending would not meet future challenges and that if investment continued at the current £800m, a further 350,000 properties in England would have a significant chance of flooding from rivers or the sea by 2035.

It recommended doubling investment in coastal and river defences by 2035, excluding inflation.

ABI spokesman Malcolm Tarling backs the Environment Agency line. “We want to make sure that flood spending is not cut. If anything, we want it to go up.”

The agency’s figures do not include investment in tackling poor drainage in urban areas, which AXA calculates was responsible for three-quarters of its flood-related claims in 2007.

In its response to the environment select committee’s recent inquiry, the insurer estimated that problems with surface water put 80,000 properties in towns and cities at risk.

It said: “A significant surface water event is likely to cost substantially more than the investment required to remove the risk.”

Dhonau says that households in flood-prone areas already face problems getting cover. Research carried out by YouGov for the forum shows that one in 10 people living in previously flooded areas were turned down when they tried to get cover.

She cites the example of a householder in Workington, Cumbria, whose application to renew cover was denied – even though their property was not flooded in last year’s deluge.

Cover stretches to 95% of households

Biba technical services manager Steve Foulsham claims that brokers are able to arrange cover for 95% of the households and businesses in flood risk areas.

He comments that insurers should become “cleverer” about how they assess risk – for example, by not denying cover to properties located on hills in otherwise flood-prone postcodes. “We feel that insurers should make

an attempt to provide better terms for these sorts of risks,” he says. “We want to ensure that flood insurance continues to be both affordable and accessible to the vast majority of consumers in the UK.”

Malcolm Tarling insists that the industry remains committed to providing cover. “Insurers don’t want to be seen to be walking away from the issue.”

Renewing the existing statement of principles is not on the agenda, he says. But it will not be easy to find a solution. One of the key issues for insurers is the extent to which the agreement distorts the market, by using other households to subsidise those in flood risk areas.

Even though the Environment Agency’s report was published before the post-election cuts, it acknowledges that central government can no longer continue to shoulder the burden of providing flood and river defences. Whitehall’s contribution currently stands at 95%.

The report concludes: “In addition to efficiency savings and voluntary contributions, it is likely that more fundamental measures – including alternative sources of funding – will be needed.”

To inform this debate, the ABI’s property committee’s recently established post-2013 working party has commissioned research that will look, among other things, at the proposal that the risks for properties that insurers are unwilling to cover be pooled, with the government acting as a funder of last resort – a replication of the set-up for terrorism-related risks.

But this idea wins little support from the industry. Biba’s Foulsham is sceptical that the government will be prepared to underwrite such risks. “It’s very much a last resort.”

Long-term contracts

Another possibility is long-term insurance contracts for those living in flood risk areas. Here, the idea is that if insurers know that they have a 10-year contract, they will be more inclined to fund flood resilience measures, such as installing more expensive water-resistant flooring.

Foulsham acknowledges that resilient repair is an issue. “At the moment, it’s difficult to get [insurers] to agree to that because if there

are any additional costs involved, their current view is that it will come under betterment.”

He criticises this approach. “If you damage your television, you don’t expect to get a second-hand one.”

Dhonau suggests that the insurance contracts could be linked to low-cost loans to fund the resilience works.

However, Foulsham wonders whether such a long-term commitment is practical.

“I am not sure that tying somebody into a 10-year contract would be the right way forward, particularly if they want to sell the property or move.”

LV= technical manager Guy Lawrence knows there must be a realistic approach to the government’s fiscal situation.

“Obviously the government has tough work to do, and flood defences are not going to be immune from cuts,” he says. “Everybody wants to see an agreement. We are reasonably positive at this stage, but there’s a long way to go and a lot of tough discussions to have.” IT