No Flood Insurance Subsidy for New UK Homes

A scheme to reduce the cost of insurance for UK homes at risk of flooding comes into effect today.  Some of the details can be criticised, but the exclusion from the scheme of new homes is absolutely right.

Flooding in parts of the UK is a fairly common event.  Winter 2015/16 brought ‘Storm Desmond’ leading to the flooding of 3,500 properties, mostly in north-west England (1).  Heavy rainfall in winter 2013/14 caused floods in several parts of southern England, Somerset being worst affected with 600 houses and much farmland flooded (2).   Other effects include disruption to transport and damage to infrastructure.  For many households, however, the most serious consequence of living in an area at risk of flooding has been the very high cost of flood insurance.

Admittedly, flooding in the UK is far less serious than in some parts of the world (3), with relatively little loss of life.  Nevertheless, flooding events such as the above always attract sustained media coverage and lead to demands for government action including immediate emergency assistance, improvements to flood protection and help to reduce insurance premiums.

If provision of insurance is left to the market, insurance companies will set premiums at levels that reflect their assessment of flood risks in particular areas, leading to very high premiums in areas of high flood risk.  Householders in such areas then face a choice between paying those premiums or leaving their property uninsured, the latter meaning that in the event of their property being flooded they would have to bear the entire cost of drying out, cleaning and repairs, and of alternative accommodation while their home was uninhabitable. They do have one other option, which is to move out of the flood risk area, but that can involve many costs and complications.  Where people have lived in an area for many years, and where the risk of flooding appears to have increased, perhaps due to climate change, it would be harsh to argue that they do not merit help because it was their choice to live in that area.

The new scheme, known as Flood Re, is the result of an agreement in 2013 between the government and insurers (4), and is underpinned by legislation (5).  Its effect will be to set a cap, at a relatively affordable level, on the flood element of buildings and contents insurance premiums.  This will mean that premiums will be much less than necessary to cover the full amount of the flood risks covered by insurers.  The difference will be funded by a tax on insurers who will almost certainly recover the cost via a small levy on all home insurance, including homes (the majority) not in areas of high flood risk.

Whether this is the best way to fund the scheme can be debated.  An alternative would be government funding from general taxation, although home insurance is so widespread that it might not make much practical difference.  Eligibility for the scheme might have been limited to people on low and perhaps middle incomes, reducing the cost to be funded.  As it is, with no income limit on eligibility, the scheme is arguably as much about supporting property markets in flood risk areas as about ensuring the affordability of flood insurance.

Another possible criticism is that the scheme will reduce the incentive for householders and local communities to try to protect themselves against flooding via measures such as keeping drainage systems in good order and not concreting over gardens and vacant land.  This is also debatable: no one would want their home to be flooded, even if fully insured; and while such small-scale measures can help, they may be less important than larger measures that may be beyond local control, such as dredging of rivers or maintenance of coastal defences.

However, an excellent feature of the scheme is that it excludes any new homes built from now on (in fact it also excludes homes built since 2009, to ensure consistency with an earlier agreement between the government and insurers (6)).  Why is this important?  Because the one certainty in this complex area is that building new homes in areas of high flood risk is bad for all concerned.  Bad for the future residents because they will have to live with the risk of flooding, even if others will bear some of the associated costs.  Bad for society generally because it will be hard for it to avoid bearing some of those costs, if only in the form of emergency help when flooding occurs.   And bad for insurers, because the risks may be hard to assess, especially in the context of climate change.  What’s more, all these bad consequences can be expected to continue for 100 years or more, the expected life of a new home.

The medical principle ‘First do no harm’ is often applicable to economic policy-making.  While environmental economists debate the finer points of taxes v marketable permits v direct regulation to limit activities that cause harm such as fossil fuel consumption, much harm around the world could be avoided simply by stopping subsidising such activities (7).  It is a merit of Flood Re that it avoids the considerable harm that would be done if the capping of insurance premiums in flood risk areas had been applied to new homes.

Notes and References

  1. Wikipedia 2015-16 Great Britain and Ireland floods
  2. Wikipedia 2013-14 United Kingdom winter floods
  3. Compare for example the effects of the 2007 South Asian floods: Wikipedia
  4. DEFRA (2013) Flood insurance agreement reached
  5. The Flood Insurance (Scheme Funding and Administration) Regulations 2015
  6. Association of British Insurers (2008) Revised Statement of Principles on the Provision of Flood Insurance
  7. International Energy Agency Energy Subsidies

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