Tag Archives: ABI

UK Floods: Don’t Say We Weren’t Warned (Part 1)

The public’s reaction to the recent extensive flooding in the U.K. has been one of surprise and frustration. Surprise at the government’s lack of prior planning for flood and frustration at the speed and size of response.

Yet, frankly, there is nothing really to be surprised about. The 2013/14 floods are part of an emerging pattern, which includes the 2003, 2007 and 2012/13 deluges. Accordingly, decisions have not been made in a vacuum; risks have been assessed by the government based on recent flood events and conscious cost-benefit choices made—and there is a paper trail of documents to prove this.

Tackling flood risk is also a classic case of decision-making under uncertainty. Floods have always followed their own probabilistic logic, but climate change has made the range of outcomes far more uncertain. Risk is probability times effect, and climate changes is pushing up flood frequency and severity. This is what both policy-makers and private individuals face.

The realisation that the U.K. has a problem with respect to flood and climate change moved from academia into government over a decade ago. This post looks at the major reports that have shaped government thinking, while the next looks at how this has translated into the speed of flood-defense roll-out and the extent of insurance provision that will be available going forward.

A decade ago, two benchmark reports were published on flood risk: one a private sector report under the auspices of the Association of British Insurers (ABI) called “The Changing Climate for Insurers”, the other a government-sponsored report called “Future Flooding” from the state’s futurology think tank The Foresight Programme. Four years later, “The Pitt Review” was released in response to the catastrophic floods of 2007. And following a recommendation within the Pitt Review, in 2009 The Environment Agency published its long-term strategy document called “Investing for the Future: Flood and Coastal Risk Management”, which looked out to 2035.

All four reports took climate change as a given. All four reports set out the hard choices that have to be made as climate change loads the dice for flood risk.

Let’s start with the ABI’s “The Changing Climate for Insurers” the Executive Summary of which can be found here. The report contains a forward by the then Head of General Insurance of the Association of British Insurers (ABI), John Parker, who was unequivocal about the role of climate change:

Climate change is no longer a marginal issue. We live with its effects every day. And we should prepare ourselves for its full impacts in the years ahead. It is time to bring planning for climate change into the mainstream of business life.

The report suggested that the finger prints of climate change were already showing up in the data:

Extreme Months jpeg

And the author of the report, Dr Andrew Dlugolecki, went on to put the government on notice that things would have to change:

Climate change will increase the frequency and severity of extreme weather events, as well as longer-term trends in weather. The possibility of weather-related catastrophic losses will be much greater, raising issues for insurers of both insurability and capacity. Insurance can only provide a suitable risk transfer mechanism if risks are kept to a manageable level. The insurance industry has a role on behalf of its customers and shareholders, in highlighting the scale of the risks, and examining steps that are needed by all parties (including the Government) to manage risks and ensure that financial protection remains available for the majority of customers.

He also put private-sector customers on alert that things would change for them too. Specifically, owners of ‘at risk’ properties would need to be prepared for ‘at risk’ insurance pricing. Moreover, ‘at risk’ would be less based on what had gone before than on what is likely to come:

The increasing use of risk pricing could enable future claims to be met, provided risks are assessed accurately. Historic claims and climate data will not provide adequate models, so reliable alternatives need to be developed.

Meanwhile, the government had put its futurology team on the case.  The Foresight Programme (which looks 20 to 80 years into the future) was asked to answer the following two questions:

  • How might the risks of flooding and coastal erosion change in the UK over the next 100 years?
  • What are the best options for Government and the private sector for responding to the future challenges?

The Foresight Flooding and Coastal Defence Report came out in April 2004 and was built around four global growth scenarios: World Markets, National Enterprise, Local Stewardship and Global Sustainability. The Executive Summary can be found here.

World Markets is the global capitalism scenario with minimal mitigation of greenhouse gas emissions; National Enterprise is World Markets with protectionism; Local Stewardship is green utopia; and Global Sustainability is statist in nature.

Based on the four scenarios, Foresight produced estimated annual damage (EAD) figures out to 2080 for both fluvial (river in this case) and coastal flooding as well as what they called intra-urban flooding (pluvial, i.e. rainwater run-off, and groundwater).

Annual Average Flood Damage jpeg

For the World Markets scenario—the dash for growth and ignore carbon emissions one—flood damage is estimated to rise 20-fold by 2080. On a GDP basis the position at first glance looks a lot better with damage only rising by 50%.

Annual Average Flood Damage % of GDP jpeg

Against current annual average cost of £1.4 billion from floods, the report estimated that £800 million per annum was spent on flood and coastal defences. Moreover, it also calculated than an annual increase in above-inflation spending of £10 to £30 million would be required just to maintain flood risk at its current level.

The report then looked at a suite of policy measures. Some would be at the macro level in terms of carbon emission mitigation, others at the local level such as increased flood defence and flood proofing. Rather optimistically, the report believed that if all their micro measures where enacted, there would be a dramatic reduction in flood-related damage. Note ‘high’ risk means a greater than one in 75 chance of flooding in any given year.

People at Flood Risk jpeg

Finally, Foresight also realised that the private sector would likely take a much more hard-nosed approach to flood insurance going forward, with the result that the government may have to step in to fill a potential insurance void.

The availability of insurance to cover the costs of flood damage will vary depending on changes in risk and society’s ability to pay. Cover could range from a continuation of the current situation to progressive withdrawal of cover for areas at greatest risk of flooding. Government might have to consider how to respond to pressure to act as insurer of last resort if the insurance market withdrew cover from large parts of the UK, or if there was a major flood which the insurance market could not cover.

The issues raised by the 2004 reports were brought into sharp relief when the British insurance industry took a £3 billion hit in 2007 after major fluvial (river and sea) and pluvial (rain) related flooding. The 2007 floods were unusual in a numbers of ways:

  • The floods took place during the summer
  • Surface water flooding (pluvial) caused as much damage as river and coastal (fluvial)
  • 55,000 houses were flooded and 13 people died
  • Half a million people lost access to mains water and electricity
  • Insurance industry claims reached £3 billion and total damage over £5 billion

In response to the 2007 floods, the government commissioned a report by Sir Michael Pitt, which was published in June 2008 as the Pitt Review. You can find the Executive Summary here.

In conjunction with the review, Sir Michael Pitt requested an update of the Foresight Future Flooding Report that I referred to above. The new Foresight report contained a more pessimistic assessment of climate change impacts on flooding. In particular, it estimated higher sea level rise and rising precipitation leading to more fluvial and pluvial flooding as compared with the 2004 analysis. It did not, however, provide updated figures for estimated annual damage from flood.

Based on the experience of 2007 and the new numbers from Foresight, Pitt recommended that the government commit to a long-term approach to investment in flood risk management, planning up to 25 years ahead. Following Pitt’s recommendation, “Investing for the Future: Flood and Coastal Risk Management” was published by the Environment Agency in 2009, and this has provided the foundation for all cost-benefit decisions regarding flood defence investment since then.

At the same time, Pitt supported the maintenance of the status quo with regard to insurance provision as contained in the Association of British Insurer’s “Statement of Principles”. Under this agreement, the ABI agreed to continue providing insurance to ‘at risk’ households at, in effect a discounted price. Low risk households would foot the bill, being charged slightly more than their risk profile would warrant. The government, meanwhile, would agree to beef up flood defence, but would not get directly involved in either insurance provision or in back-stopping major catastrophe loss.

The ABI had other ideas. The 2007 floods saw 180,000 claims and insurance payouts of £3 billion. The worry for insurance executives was that if 2007 could produce a £3 billion loss event, then what could happen once climate change really accelerated? The possibility existed of an open-ended loss of inestimable proportions. The insurance industry can absorb large losses by just hiking premiums in future years, but a super-large tail risk loss event is a different matter. At a certain point, insurers can be knocked out of business, and thus not survive long enough to hike future premiums.

Faced with the ABI’s implicit threat to walk away from ‘at risk’ households and leave them uninsured, the government realised Pitt’s idea of a continuation of the status quo was a non-starter—and so was born Flood Re. I will look at this agreement in my next post, along with the cost-benefit choices the government is being forced to make with flood defences.

Flood Risk in the U.K.: What Does Mr. Market Think? (Part 4 You Ain’t Seen Nothing Yet)

The National Flood Risk Assessment  (NaFRA) of 2008, conducted by the Environment Agency (EA), calculates that 330,000 properties are at ‘significant’ risk (defined as one in 75 years) of fluvial flood in England. The survey is a bit long in the tooth nowadays, and I expect that if they repeated the assessment exercise today, more houses would fall into the ‘significant’ risk category.

In a similar vein, The Association of British Insurers’ (ABI) submission to the U.K. parliament talks of around 200,000 homes (some 1 to 2 percent of the total housing stock) that would now find it difficult to obtain flood insurance if open market conditions solely determined availability (and if they can’t get insurance, they won’t be able to support a mortgage).

For climate change “skeptics” who believe in free markets, the fact that the British insurance industry takes climate change as a given, and has done so for many years, is a difficult fact to face. In a forward to a report called “The Changing Climate for Insurers” back in 2004, The ABI’s then Head of General Insurance John Parker was unequivocal:

Climate change is no longer a marginal issue. We live with its effects every day. And we should prepare ourselves for its full impacts in the years ahead. It is time to bring planning for climate change into the mainstream of business life.

What the ABI is doing through requesting the government to create a new insurance arrangement after the expiry of the Statement of Principles agreement in June 2013 is to “prepare ourselves for (climate change’s) full impacts in the years ahead”. We can hardly say we were not warned.

We can also hardly say that climate change is alarmist nonsense or a socialist plot. The insurance industry is about as close to “red in tooth and claw” capitalism as one could get. And the message from Mr. Market in his insurance industry incarnation is very clear: climate change is coming to a place near you very soon—get used to it.

Yet the ABI has blurred the line between uninsurability and unafordability. Tim Hartford in his Financial Times’ “Undercover Economist” column sets out three hard-to-insure risks. First, genuine unknown unknowns, where the insurer has no idea of the shape of the frequency distribution and severity distribution. Second, the adverse selection situation, where there is an asymmetry of information acting against the insurer: those who know they are bad risks use their effective insider knowledge to seek out and profit from insurance. Finally, insurance that is just expensive. He puts flood insurance into the final category:

Now the third kind of hard-to-insure risk is stuff that’s expensive and happens quite often. I’m trying to buy a house, I’m nearly 40 and so I’m trying to buy insurance for my family in case I die or become too ill to work. This is perfectly possible: it’s just expensive, because it’s not unusual for middle-aged men to get seriously ill. This sounds like a much better description of allegedly uninsurable homes: if there is a one in five chance of a flood, and a flood is going to cost £50,000, don’t expect to pay less than £10,000 a year for flood insurance.

…..but unaffordability is not uninsurability. It’s insurable but expensive.

If these homes actually were uninsurable the government would need to step in and cut some kind of deal with the insurance industry – exactly the kind of deal that has lasted for the past few years and seems about to unravel. But if the problem is unaffordability, trying to solve it by cutting a deal with the insurance industry is just a way of obscuring what is really going on. The real solution is simple and stark: the government needs to decide whether it wants to pay people thousands of pounds a year to live in high-risk areas or not.

And in austerity Britain, no Chancellor of the Exchequer really wants to shoulder these extra payments. Continue reading

Flood Risk in the U.K.: What Does Mr. Market Think? (Part 3 The Information Game)

In my last post, we saw that the insurance industry has broken with the status quo because it realises that flood risk has entered into a new era. The stable frequency and loss distributions that underpinned their actuary-led calculations of the past are no more. The loss-related data that the industry laboriously collected in the past only gives insurers a limited ability to look into the future.

Nonetheless, if we only think of the pure insurance risk (as opposed to an insurer’s business model risk), insurance companies are really looking out only one year: when a home owner’s policy comes up for renewal each year, the insurer has the opportunity to change the terms and conditions of the policy including the premium and excess. And they could change the terms and conditions very aggressively—the equivalent of suspending coverage, just in disguise.

Given these factors, if an insurer can look out for that one year and capture a decent understanding of the risk, it should be protected from any massive loss event that blows it out of business. And if there is a big loss event and the insurance company is still standing, it can subsequently change the terms and conditions of the outstanding policies at the next yearly renewal including a hefty hike in the premiums.

Up until the floods of 2007, with their £3 billion-plus associated insurance pay-outs, the information in the hands of an insurer and a well-informed home owner would have not been that much different. Both would have had access (and still do have access) to the Environment Agency (EA)’s flood maps.

The flood maps are updated quarterly and give a risk assessment at the one in 100 and one in 1000 flood probability levels  for river flooding (an EA pamphlet on the flood map can be found here). On top of this, the EA provides the insurance industry with the National Flood Risk Assessment (NaFRA) data. As mentioned in a previous post, this is more specific in terms of its flood risk categories (an EA pamphlet on NaFRA can be found here) and underpins the Statement of Principles agreement between the Association of British Insurers and the government. I will repeat the risk category definitions once again:

  • Low risk: the chance of flooding each year is 0.5 per cent (1 in 200) or less
  • Moderate risk: the chance of flooding in any year is 1.3 per cent (1 in 75) or less but greater than 0.5 per cent (1 in 200)
  • Significant risk: the chance of flooding in any year is greater than 1.3 per cent (1 in 75)

A home owner may have more interest in the one-in-75 risk (available from NaFRA) rather than the one-in-100 risk (available from the EA on-line Flood Map) since this is the demarcation point used to differentiate between ‘significant’ risk and ‘moderate’ risk, and as a result drives insurance premiums levels. Moreover, this risk demarcation point gives an some indication of what ‘significant’ risk property owners may be in for after the expiry of the Statement of Principles agreement expires in June 2013. Continue reading

Flood Risk in the U.K.: What Does Mr. Market Think? (Part 2 An Actuary’s Nightmare)

In my previous post, I noted that strange things were happening in the flood insurance market. In short, the insurance industry no longer wants to extend the status quo (here):

The current agreement under which insurers continue to offer flood insurance to their existing customers will expire on 30 June 2013. The insurance industry has proposed a new a scheme to ensure customers can still buy affordable flood insurance, after this date. We are currently in talks with the Government about taking this forward.

In truth, they want to move some flood risk from one actor in the market to another. But before I look at that issue, I want to ask the question “why do they want to change the status quo?”

To do this, we need to take a quick detour through the theory of insurance. There is a nice little eight-minute youtube video that explains the theory of insurance here:

The core message in the video is the same as the core message of this blog: risk is the probability of an event times the cost of the event. Continue reading

Flood Risk in the U.K.: What Does Mr. Market Think? (Part 1 Five Million Homes at Risk and Rising)

Last week I attended an evening of talks given under the title “Extreme Weather and Floods” and hosted by the local sustainability group PAWS in the Thames side village of Pangbourne. The speakers were Professor Nigel Arnell,  Director of the Walker Climate Institute, Reading University, and Stuart Clarke, Principal Engineer and the senior officer for flood risk management at West Berkshire Council.

At the close of the Q&A at the end of the evening, the moderator encouraged the audience to mingle with the speakers and take the opportunity to ask any follow-up questions.  I ambled up to Professor Arnell to ask for a pdf copy of his Powerpoint slides, but before I could get to him he was grabbed by a late middle-aged man who wanted to vent his frustrations on his treatment by his insurance company (I shall call him Mr. Angry, and don’t blame him). The insurer was now demanding a £1,400 (about $2,100) annual insurance premium for flood risk cover and a £15,000 (about $23,000) excess for flood damage (the home owner has to pay the first £15,000 of damages before the insurer steps in). Result? He declined and his house now goes uninsured.

Flood insurance is a classic case of where climate change meets Mr. Market. At present, U.K. insurers have an agreement with the government known as the Statement of Principles on the Provision of Flood Insurance (a copy can be found at the Association of British Insurers here) that can be summarised as Mr Market Lite.

The border line between capitalism ‘red in tooth and claw’ and the socialization of risk is a one-in-75 year flood event (a 1.3% chance of flooding in an individual year). If you are in a flood zone which is estimated to have a flood risk greater than one in 75 years and the government has no plan to beef up flood defences over the next 5 years, then ‘tough’—you have to make an accommodation with Mr. Market. If—like Mr. Angry of Pangbourne above—Mr. Market’s quote is in the stratosphere, then you may be forced to turn it down and go uninsured. Note that if your property was built after 1 January 2009, it automatically falls outside of this agreement between the insurers and the government.

You can see the definitions of ‘low’, ‘moderate’ and ‘significant’ risk in the Environment Agency’s “Flooding in England: A National Assessment of Risk” here (click for larger image).

Flood Risk Categories jpeg

Continue reading