In the February 2015 edition of our Surveyors & Valuers Newsletter, we considered the likely impact of the Flood Re scheme on property valuations and the risks the scheme might create for surveyors & valuers. At that time, it was anticipated that Flood Re would come into force in July 2015. However, setting up the scheme has proved more difficult than expected and implementation is now expected by April 2016. In this brief article we outline the current position and the scheme’s anticipated structure.
Flood Re is a government backed re-insurance scheme owned and operated by the UK insurance industry. Insurers will identify the highest risk 1-2% of homes in the UK, thought to be around 350,000 properties, and re-insure those risks at a fixed premium within a collective “pool”, allowing insurers to cap the cost of these risks and to compete to offer affordable premiums for otherwise high risk properties.
Flood Re was passed into law in the 2014 Water Bill and the regulations as to how Flood Re will operate, the Flood Reinsurance (Scheme Funding, Administration and Amendment) Regulations 2015 (‘the Regulations’) were separately laid before Parliament in April 2015.
Flood Re will be a not-for-profit private company collectively owned by the insurance industry, similar to the terrorism risk pool, Pool Re.
The scheme is funded by:
- Premiums paid on the properties within the scheme, based on council tax banding and capped at GBP 210 for bands A and B, rising to GBP 1,200 per annum for Band H (Band I in Wales)
- A fixed excess of GBP 250 per claim per property
- A cross-subsidy on all residential buildings and contents insurance policies of around GBP 10.50 per policy. The subsidy, totalling GBP 180 million per annum, will be collected as a statutory levy from all householders and is provided for by the Regulations
Flood Re will then reinsure the risk held in the scheme on the open market with a lower limit of cover of GBP 250 million. The scheme is designed to hold sufficient funding for a “1 in 200 year” disaster, the cost of which is assessed at around GBP 2.4 billion. The Government has agreed to meet any liabilities in excess of this ceiling.
As the scheme is funded primarily by the statutory levy, it must meet strict criteria imposed by public procurement rules and its senior figures will be directly accountable to Parliament. In addition, the scheme must also fulfil the requirements, including those as to capitalisation, imposed by the Financial Conduct Authority and the Prudential Regulation Authority (“PRA”). While these challenges have caused delays in the implementation of Flood Re, the scheme has this month started the on-boarding process for participating insurers working toward a revised launch date of April 2016.
Taking into consideration the multi-billion pound cost of floods in 2007 and 2012, there are serious concerns that the scheme will be undercapitalised in its early years and unable to meet its liabilities in the event of a major flood. The scheme’s lower limit of insurance of GBP 250 million will do little to guard against a re-run of, say, 2012’s events.
Flood Re must now demonstrate to the PRA that it has access to sufficient capital to meet its full liabilities should a major flood occur. Provision has therefore been made for an additional, ad-hoc, statutory levy to be raised from ABI members to cover any shortfall which may arise. This additional levy may be raised without recourse to Parliament, to allow immediate payment to households in the event of a major flood, with the additional costs passed on to consumers by way of the cross-subsidy.
It is believed that the power to raise the additional levy, alongside the ‘last resort’ guarantee provided by the Government, will be sufficient to meet the capitalisation requirements, but until the worst happens, there can be no certainty in this regard.
Although Flood Re is designed to cover residential properties in high risk areas for flooding, some properties are excluded, either because they are classed as commercial property, or for policy reasons:
- Apartments in blocks of 4 or more properties or buildings split into 3 properties where the freeholder is not resident
- Buy-to-Let properties
- Properties in high-risk areas built after 1 January 2009
Whether these exclusions are reasonable remains to be seen. With the Regulations governing the scheme yet to be finalised, it will be interesting to see if any legal challenge is made to the decision to exclude apartment blocks or Buy- to-Let properties in particular. Given the stated purpose of Flood Re, it is arguably unreasonable to exclude any type of residential property from the scheme. Similarly, those living in properties built in the last 6 years may argue that their exclusion is arbitrary and unfair.
Additionally (although not yet the subject of great discussion) there are an increasing number of units designated as “live-work” spaces by local authorities. Such properties may require business insurance, dependent on the nature of the work to be carried out on the premises and, if so, under the present rules, would not be eligible for Flood Re. As these properties become more prevalent and the range of insurance products available increases, guidance will likely be required on the scheme’s approach to these units.
Flood Re is a welcome step to address the risks posed by climate change and the increased financial costs of flooding to insurers. However, the scheme, as presently outlined, has the potential to be extremely divisive, creating significant variations in the insurability (and therefore value) of properties based entirely on the nature of their ownership rather than the physical risk of flooding. Until implementation, properties affected by flooding remain exposed to the open market, and many will be uninsured due to prohibitive risk based pricing. Further significant improvements to flood defences will still be required in the coming years to ensure prohibitive insurance premiums (or blanket uninsurability) are not an issue on the scheme’s expiry in 25 years. Flood Re may yet prove to be no more than a holding measure, and an inadequate one at that.