Recent headlines about the number of UK properties which are at risk from flooding have brought the availability and affordability of flooding insurance back into focus.
Expiry of the Statement of Principles (SoP)
The SoP made by the Association of British Insurers (ABI) in 2008 commits members of the ABI to continuing to offer flood insurance cover, until June 2013, to residential properties and small business in England and Wales, if the flood risk was not significant. A flood risk is considered to be significant if the annual probability of flooding is greater than a one in 75 chance of occurring.
The SoP also commits ABI members to offering cover to residential properties and small business in England and Wales which are at a significant flood risk, provided that the Environment Agency intended to reduce the risk of flooding and to implement a programme of flood defence improvements in the area within a period of five years. However, the SoP does not extend to commercial properties or to new properties built after 1 January 2009.
The SoP operates to subsidise those properties at a significant risk of flooding. With the expiry of the SoP on the horizon in June 2013, there is concern that those properties at significant risk currently covered by the SoP will become harder and more expensive to insure. The effect of the expiry of the SoP may well be felt as early as July 2012, as policies granted from this date will continue past the expiry of the SoP and insurers will be free to offer insurance on their own market terms.
The Government’s response
A Defra report (Flood risk and insurance: A roadmap to 2013 and beyond) published in December 2011 has reiterated the Government’s commitment to the continuing availability of flood insurance to properties at a significant risk of flooding after the expiry of the SoP. The report considers various models of how best to ensure the availability of flood insurance for homeowners: first, a free market; second, some form of subsidy for high risk properties within the context of a free market; and third, improving the public’s awareness of insurance and information about flooding, again within the context of a free market (which it is hoped would ensure a greater uptake of insurance where cover is still available).
Unfortunately, the report does not indicate which model should be adopted for the future, although it is hoped that there will be a further announcement from the Government in spring 2012.
The SoP does not apply to commercial properties (other than small businesses) or to buildings built after 1 January 2009, but the expiry of the SoP can be set within the wider context of climate change, and increased instances of flooding which has changed the approach of insurers to flood risk cover.
Insurers are using increasingly more sophisticated methods to assess a property’s risk and calculate the premium. They are considering not only river and coastal flooding, but also surface and groundwater flooding. The inclusion of surface and groundwater flooding has increased the number of UK properties now considered to be at risk from flooding.
The expiry of the SoP and the emergence of a free market may mean that for certain properties flood risk cover will no longer be available. However, it is more likely that the expiry of the SoP will increase the cost of insurance cover for properties assessed to be at significant risk, and that the policies available will provide for wider exclusions, greater excesses and impose conditions requiring alterations to make properties more resilient to damage caused by flooding.
Mortgage financing is an issue for both commercial and residential properties and will be harder to secure where it is difficult to obtain and maintain cover against flooding risk. For those with mortgages already in place, the standard commercial loan agreement term requiring a borrower to take out full comprehensive buildings insurance would be breached if a borrower is unable to maintain flood risk cover because it is too expensive or not available. Such difficulties in securing finance may decrease the value of a property and make it harder to sell on.
While larger investors who are able to keep insurance costs low by way of block policies will not have the same problems in obtaining affordable insurance while they still own the property, they may experience reductions in the value of particular properties within their portfolios, if selling on to smaller buyers who do not enjoy the equalising benefit of a block policy.
In recent years, commercial leases have increasingly included provisions to except damage caused by uninsured risks from a tenant’s repairing obligations. Tenants have sought the inclusion of such provisions to guard against becoming the insurer of last resort and landlords have agreed largely on the assumption that uninsured risk provisions were very unlikely to come into play. If flooding risk cover is not available or there is a possibility that cover may not be available during the life of the lease, landlords may wish to consider a specific exclusion of flooding from any definition of uninsured risks used in the lease. However, in the current market it is unlikely that a tenant will be prepared to enter into a lease unless the landlord bears any risk relating to damage caused by flooding.
It has been reported that the Commons Select Committee for Environment Food and Rural Affairs has highlighted the pressing need for the Government to reach further agreement with the ABI. In the meantime, it is more important than ever to consider whether flooding is a concern at the outset of a transaction so that the availability and cost of insurance can be considered in good time both with a view to the immediate purchase or development, and in terms of onward sale. Various searches are available to lawyers and their clients ranging from simple desktop searches, to searches involving site visits and full flood risk assessment.
If there are concerns about the level of flood risk affecting a property, the buyer or tenant can consider asking for a reduction in the purchase price or rent to leave money available to carry out improvements to flood defences, or to meet the higher premium or repair any damage caused by flooding. Occupiers can also look at using properties in ways that are the most sensitive to the risk of flood damage, for example by housing papers and electrical equipment away from ground level.